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EX-10.15 - EXHIBIT 10.15 - GenMark Diagnostics, Inc.gen-20161231ex1015.htm
EX-32.2 - EXHIBIT 32.2 - GenMark Diagnostics, Inc.gen-20161231ex322.htm
EX-32.1 - EXHIBIT 32.1 - GenMark Diagnostics, Inc.gen-20161231ex321.htm
EX-31.2 - EXHIBIT 31.2 - GenMark Diagnostics, Inc.gen-20161231ex312.htm
EX-31.1 - EXHIBIT 31.1 - GenMark Diagnostics, Inc.gen-20161231ex311.htm
EX-23.1 - EXHIBIT 23.1 - GenMark Diagnostics, Inc.gen-20161231ex231.htm
EX-10.31 - EXHIBIT 10.31 - GenMark Diagnostics, Inc.gen-20161231ex1031.htm
EX-10.23 - EXHIBIT 10.23 - GenMark Diagnostics, Inc.gen-20161231ex1023.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________ 
FORM 10-K
____________________________________________ 
 
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the year ended December 31, 2016
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from to            
Commission File Number: 001-34753
 ____________________________________________ 
GenMark Diagnostics, Inc.
(Exact name of registrant as specified in its charter)
____________________________________________ 
Delaware
 
27-2053069
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
5964 La Place Court, Carlsbad, California
 
92008-8829
(Address of principal executive offices)
 
(Zip code)
 
Registrant’s telephone number, including area code: 760-448-4300
 
Securities registered pursuant to Section 12(b) of the Act
Title of Each Class:    
 
Name of Each Exchange on which Registered:    
Common Stock, par value $0.0001 per share
 
The NASDAQ Stock Market LLC
(NASDAQ Global Market)
 
Securities registered pursuant to Section 12(g) of the Act: None
 ____________________________________________ 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended.    YES  ¨    NO  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended.    YES  ¨    NO  x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x    No  ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨            Accelerated filer  x            Non-accelerated filer  ¨            Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
 
As of June 30, 2016, the last business day of the registrant’s most recent completed second quarter, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $350,814,000 based on the closing sale price for the registrant’s common stock on the NASDAQ Global Market on that date of $8.70 per share. This number is provided only for the purpose of this report on Form 10-K and does not represent an admission by either the registrant or any such person as to the status of such person.
 
The number of outstanding shares of the registrant’s common stock on February 24, 2017 was 47,051,202. The common stock is listed on the NASDAQ Global Market (trading symbol “GNMK”).
   ____________________________________________ 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year are incorporated by reference into Part III of this report.
 




TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
 
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
Item 15.
 
 
 
Item 16.

1


Forward-Looking Statements
 
This Annual Report on Form 10-K, or Annual Report, particularly in Item 1. “Business” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the documents incorporated herein by reference, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements, other than statements of historical fact are statements that could be deemed to be forward-looking statements, including, but not limited to, statements regarding our future financial position, business strategy, research and development efforts, and plans and objectives of management for future operations. When used in this Annual Report, the words “believe,” “may,” “could,” “will,” “estimate,” “continue,” “intend,” “expect,” “target,” “anticipate,” “aim,” “plan” and similar expressions, including their use in the negative, are intended to identify forward-looking statements.
 
These forward-looking statements are based on current expectations, estimates, forecasts and projections about our business and the industry in which we operate and management’s beliefs and assumptions. They are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this Annual Report may turn out to be inaccurate. Risks and other factors that may cause such differences include, but are not limited to, those described under the heading “Risk Factors” in Item 1A of Part I of this Annual Report.
 
In light of these risks, uncertainties and assumptions, actual results and timing of events could differ materially and adversely from those anticipated or implied in the forward-looking statements. Accordingly, readers are cautioned not to place undue reliance on such forward-looking statements.

Except as required by law, we do not intend to update these forward-looking statements publicly or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
 
Trademarks and Trade Names
 
GenMark®, eSensor®, XT-8® and ePlex® and our other logos and trademarks are the property of GenMark Diagnostics, Inc. or its subsidiaries. All other brand names or trademarks appearing in this Annual Report are the property of their respective holders. Our use or display of other parties’ trademarks, trade dress or products in this Annual Report does not imply that we have a relationship with, or the endorsement or sponsorship of, the trademark or trade dress owners.
 
Use of External Estimates
 
This Annual Report includes market share and industry data and forecasts that we obtained from industry publications and surveys. Industry publications, surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of such included information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. While we are not aware of any misstatements regarding the industry and market data presented herein, the data involve risks and uncertainties and are subject to change based on various factors.

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PART I.
 
Item 1.
BUSINESS
 
GenMark Diagnostics, Inc., or GenMark, is a molecular diagnostics company focused on developing and commercializing multiplex molecular tests that aid in the diagnosis of complex medical conditions and help guide therapy decisions. References herein to “we,” “us” or “our” refer to GenMark Diagnostics, Inc. and its wholly owned subsidiaries, unless the context specifically requires otherwise.
 
Overview
 
We currently develop and commercialize high-value, simple to perform, clinically relevant multiplex molecular tests based on our proprietary eSensor electrochemical detection technology. We currently sell our XT-8 instrument and related diagnostic and research tests, as well as certain custom manufactured reagents, which collectively we refer to as our XT-8 system. Our XT-8 system supports a broad range of molecular tests with a compact and easy-to-use workstation and disposable test cartridges. In addition, we have developed and are commercializing of our sample-to-answer ePlex instrument and Respiratory Pathogen (RP) Panel. We intend to offer a number of additional associated diagnostic tests for use with our ePlex instrument, which we collectively refer to as our ePlex system.

Since inception, we have incurred net losses from operations each year, and we expect to continue to incur losses for the foreseeable future. Our net losses for the fiscal year ended December 31, 2016 and 2015 were approximately $50.6 million and $42.2 million, respectively. As of December 31, 2016, we had an accumulated deficit of $355.3 million. Our operations to date have been funded principally through sales of capital stock, borrowings, and cash from operations. We expect to incur increasing expenses over the next several years, principally to commercialize our ePlex system, as well as to further increase our manufacturing capabilities and domestic and international commercial organization.
 
Our Strategy
 
Our goal is to become the market leading provider of automated, multiplex molecular diagnostic testing systems. In order to achieve this objective, we intend to:
 
Successfully Commercialize our ePlex System.    We believe the ePlex system is an attractive solution for a broad range of hospitals and laboratories that lack the technical or economic resources to perform molecular diagnostic testing with existing products and technology. We believe the ePlex system will expand our current potential user base from approximately 1,000 domestic customers to approximately 12,000 potential customers globally.
Expand our Menu of Clinical Diagnostic Products.    We intend to develop a broad menu of molecular diagnostic tests for our ePlex system that we believe will satisfy important medical needs and present attractive commercial opportunities. For example, in June 2016 we obtained CE Mark of our ePlex instrument and RP Panel, and in December 2016 we submitted 510(k) applications to the United States Food and Drug Administration, or the FDA, for our ePlex instrument and RP Panel.  During 2017, we intend to complete the development of, CE Mark, and submit 510(k) applications to the FDA our ePlex blood culture identification (BCID) family of panels, which include a gram-positive (GP), a gram-negative (GN), and a fungal pathogen panel.  In addition, we are actively evaluating the development of additional assay panels that we believe will meet important, unmet clinical needs, which our ePlex system is uniquely positioned to address.
Grow our Installed Base of Customers. We have identified those laboratories and hospitals that we believe will benefit from our product portfolio. We intend to leverage our commercial organization to drive placements of our ePlex system both domestically and internationally. We anticipate that the expansion of our installed base of customers will drive sales of our test cartridges, from which we anticipate generating the majority of our revenues for the foreseeable future.
Increase Test Utilization.    We intend to increase the use of our diagnostic tests by developing and offering tools and support tailored to our products such as education programs and seminars, product training for our customers, and reimbursement support. These activities are designed to aid in establishing the clinical and health economic utility of multiplex molecular diagnostic tests, which we believe will increase adoption of our products.
Revenues, net loss, and total assets for the past three years are contained in our consolidated financial statements in Part II of this Annual Report. Substantially all of our revenues for the periods reported in our consolidated financial statements in Part II of this Annual Report were derived from customers located within the United States.


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Our Technology

Our eSensor Technology

Our proprietary eSensor technology is based on the principles of deoxyribonucleic acid, or DNA, hybridization and electrochemical detection. DNA naturally forms a double-stranded structure, with each strand binding with high affinity, or hybridizing, only to a complementary strand. Our technology takes advantage of this highly specific binding by first creating two types of single-stranded DNA, the capture probe and the signal probe. The capture probe and signal probe are each complementary to a different segment of the target DNA that is the focus of the particular diagnostic test. Using our technology and processes, we attach our capture probes to a proprietary monolayer on the surface of a gold electrode within our test cartridges. We separately attach ferrocene, a proprietary label, to our signal probes.

Before placing the sample into our XT-8 test cartridge, the technician mixes the amplified DNA sample with our signal probe. If the target biomarker is present in the prepared patient sample, a segment of the biomarker DNA will hybridize with a solution containing our signal probe. This solution is then run past an electrode, against which our capture probes have been immobilized. The as-yet unbound segment of the target biomarker binds to our capture probe, creating a target DNA, signal probe, capture probe complex at the surface of the electrode. This complex produces an electrochemical signal which is analyzed and interpreted by our XT-8 system.

With our ePlex sample-to-answer test cartridges, the operator adds a patient sample directly or with minimal preparation into the sample chamber, closes the lid, and inserts the test cartridge into the ePlex instrument. Within the instrument, the same steps performed by a technician with the XT-8 system are performed within the ePlex test cartridge, resulting in the delivery of target DNA and signal probes to the eSensor electrodes within the ePlex cartridge. As with XT-8, when a complex forms as a result of a target match, the complex produces an electrochemical signal that is interpreted by the ePlex system.

Our XT-8 and ePlex test cartridges utilize the combination of distinct electrodes and multiple signal probes to detect dozens of target biomarkers from a single sample, thereby enabling highly multiplexed testing. Our eSensor technology is highly specific for the target biomarker, and is not based on optical or fluorescent detection. As a result, our diagnostic tests are less prone to sample contamination risk and do not require many of the time-consuming washing and preparation steps required by competing technologies. The sample preparation steps required before using our XT-8 test cartridges are nucleic acid purification and a polymerase chain reaction, or PCR, amplification, which involves amplifying, or generating billions of copies of the target DNA molecules, followed by transfer of the sample to our test cartridge and insertion of the test cartridge into any open module in our XT-8 system. In some XT-8 tests, amplified DNA is subject to an additional enzymatic treatment to produce a single-stranded-DNA. In contrast, the ePlex system generally requires no pre-analytic steps to be performed by the user, except, in limited cases, certain minimal up-front sample handling.

We believe our proprietary electrochemical detection technology has several advantages over other signal detection platforms, including high sensitivity and accuracy, streamlined sample preparation, efficient multiplexing, effective use of lab space, low maintenance, and the ability to cost-effectively develop additional tests.

Digital Microfluidics

Digital microfluidics is another innovative technology included within our ePlex system which we have exclusively licensed within a defined field of use from an affiliate of Illumina, Inc. Digital microfluidics is a technique for moving small droplets of liquid using electrowetting, a process for making a surface hydrophobic or hydrophilic based on the application of a voltage to a surface. Our ePlex printed circuit board contains eSensor electrodes capable of nucleic acid detection along with electrowetting electrodes capable of digital microfluidics. The ePlex system uses numerous choreographed digital inputs to perform the fluid manipulations associated with sample-to-answer molecular diagnostics. Drops are dispensed, mixed, merged, heated, cooled, split and delivered, all under precise and programmable digital control. In this manner, standard procedures of the molecular diagnostics lab (e.g., DNA purification, PCR, exonuclease digestion, etc.) can be performed automatically within our ePlex cartridge.

 Our Instrument Systems
 
Our XT-8 System.    Our XT-8 instrument is a post-PCR multiplex workstation that has a modular design consisting of an integrated touch screen and up to three analyzers. Each analyzer contains eight modules into which individual test cartridges are placed. The test cartridge modules operate independently of each other allowing up to 24 independent test cartridges to be loaded at one time, with the remaining modules available for use at any future time while the system is running.


4


We believe that our XT-8 system offers reference laboratories and hospitals the following benefits:
Key Features & Benefits
Description
Broad Test Menu
We offer the following four FDA-cleared assays on our XT-8 instrument: a Respiratory Viral Panel, Cystic Fibrosis Genotyping Test, Thrombofilia Risk Test, and a Warfarin Sensitivity Test. We also offer a Hepatitis C (HCV) Genotyping Test and associated custom manufactured reagents, as well as a 2C19 Genotyping Test, each of which is available for research use only (RUO).
Fast Turnaround
Approximately 30 minutes post-PCR to result from an amplified DNA sample with minimal technician time needed.
Accurate Results
Our Cystic Fibrosis Genotyping Test, our Warfarin Sensitivity Test and our Thrombophilia Risk Test demonstrated 100% accuracy in clinical studies compared to DNA sequencing and other standards.
Ease of Use
Minimal manual processing steps, intuitive touch-screen interface and clear result reports.
Random Access
Each of up to 24 test cartridge modules can be accessed independently resulting in a highly flexible workflow.
Minimal Maintenance
No routine maintenance or calibration is required.
Multiplex Capability
Detects numerous distinct biomarkers in a single sample reducing the need for reflex testing.

Our ePlex System.    Our ePlex instrument is a multiplex, sample-to-answer platform that fully integrates nucleic acid extraction, amplification and detection and has a modular design consisting of an integrated touch screen and up to four analyzers. Each analyzer contains six modules into which individual ePlex panel test cartridges are placed. The test cartridge modules operate independently supporting continuous random access of up to 24 independent test cartridges.

We believe our ePlex system offers reference laboratories and hospitals the following benefits:
Key Features & Benefits
Description
Broad Test Menu
We obtained CE Mark for our ePlex system and RP Panel in June 2016, and filed 510(k) applications with the FDA for the ePlex instrument and RP Panel in December 2016. During 2017, we intend to complete the development of, CE Mark, and submit 510(k) applications to the FDA our ePlex blood culture identification (BCID) family of panels, which include a gram-positive (GP), a gram-negative (GN), and a fungal pathogen panel.  In addition, we are actively evaluating the development of additional assay panels that we believe will meet important, unmet clinical needs, which our ePlex system is uniquely positioned to address.
Ease of Use
Minimal manual processing steps, intuitive touch-screen interface and clear result reports.
True Sample-to-Answer
The user simply adds a raw or minimally prepared sample to the test cartridge and inserts the cartridge into the instrument. 
Fast Turnaround
Results are capable of being produced in approximately 1-2 hours from sample input.
Random Access
Each of up to 24 test cartridge modules can be accessed independently resulting in a highly flexible workflow.
Minimal Routine Maintenance
Minimal maintenance or calibration is required.
Multiplex Capability
Detects numerous distinct biomarkers in a single sample reducing the need for reflex testing.
Positive Patient Identification (PosID)                 
Incorporates patented positive patient identification technology to reduce sample reporting errors.
IT Integration
Multiple design features to improve operational efficiency, such as bi-directional laboratory information system (LIS) connectivity and remote access capability to reduce downtime and service costs.

Market Opportunity
 
We believe the aggregate global total addressable market for the tests we currently offer, are actively developing on ePlex, or may consider developing is approximately $2.5 billion. Many factors are driving the strong opportunity in this market, including increased demand for infectious disease diagnostic solutions and an increased focus on value-based medical care that enhances patient outcomes, improves key quality metrics, and reduces the total cost-of-care.

5



Research and Development
 
Our research and development (R&D) team is focused on expanding our ePlex test menu. In addition, our R&D team is supporting the following initiatives:

On Market Product Support.    A role of our R&D team is to assist our manufacturing and quality assurance teams in ensuring high product quality and thorough complaint handling and investigation. This team also supports improvements in quality control methods and metrics and are active participants in the continuous improvement processes utilized by our product manufacturing teams.

Improving the Clinical and Practical Utility of our Tests.    Our R&D organization also supports the clinical utility and value of our molecular diagnostic tests. We have previously and intend to continue to partner with academic and reference laboratories to perform validation and clinical studies on our tests. Key aspects of our efforts are aimed at improving workflow in the laboratory setting, positively comparing our tests to historical or “gold standard” tests, and demonstrating that our tests can help improve patient care and lower diagnostic and medical treatment costs. We intend to publish the results from these clinical studies in peer-reviewed or trade journals, submit them to regulatory bodies and present them at industry conferences in support of our commercialization strategy.

Manufacturing
 
We manufacture our proprietary test cartridges, certain related components and ancillary reagents in our Carlsbad, California facilities. We perform reagent formulation, test cartridge manufacturing and packaging of final components and test cartridges in accordance with applicable guidelines for medical device manufacturing. We currently lease an aggregate of approximately 87,000 square feet at two nearby locations in Carlsbad, California, where we maintain our corporate office and manufacturing facilities.

We currently outsource the manufacture of our XT-8 instrument to Leica Biosystems Melbourne Pty Ltd., or Leica, and outsource the manufacture of our ePlex instrument to Plexus Corp, or Plexus. We rely on third party suppliers, including in certain instances, sole source suppliers, for certain raw materials and other supplies and components used in our products.
 
We have implemented a quality management system designed to comply with FDA regulations and ISO standards governing diagnostic medical device products. These regulations control the design, manufacture, testing and release of diagnostics products, as well as raw material receipt and control. In 2012, our Carlsbad, California corporate headquarters facility obtained ISO 13485 certification. We control methods for the consistent manufacturing of our proprietary test cartridges and reagents at our facilities. Our key outsourcing partners are regularly audited to help ensure a continual supply of high quality components.

We plan to continue to manufacture components that we determine are highly proprietary or highly customized, while outsourcing more commodity-like components. We are likely to establish additional outsourcing partnerships as we manufacture additional products.
 
Sales and Marketing
 
Our current sales and marketing strategy is to expand our business globally with the commercialization of our ePlex system in the United States and Europe, while also continuing to support the placement and use of our XT-8 system in the United States. Our products are sold in the United States through a geographically dispersed direct sales and technically specialized service organization, which is supported by a centralized team of product managers and marketing, customer support, and technical support personnel. We utilize a direct sales and technical support team to sell our ePlex system in certain key European countries, which are augmented by distributors in other locations internationally.

Our sales representatives typically have experience in molecular diagnostics and a network of laboratory contacts within their respective territories. We utilize our representatives’ knowledge along with market research databases to target and qualify our customers. We execute a variety of sales campaigns and strategies to meet the buying criteria of the different customer segments we serve. To support the growth in our customer base and our launch plans for our ePlex system, we continue to make investments in these customer facing organizations.

Our sales cycle typically includes customer evaluations and validations of our products. Upon successful validation, a customer may generally acquire our instrument system in the following ways:


6


Capital Purchase:    The instrument is paid for upfront and in its entirety by the customer. Customers are also eligible to receive structured pricing incentives if they enter into an optional annual minimum cartridge purchase commitment. 
Reagent Rental:     A reagent rental agreement requires that a customer commit to purchase a minimum number of test cartridges over the term of the agreement, and a portion of the charge for each cartridge is attributable to a usage fee for the instrument.

Customers
 
Our target customers include hospital-based laboratories and research institutions. We believe our ePlex system will expand our current potential user base from approximately 1,000 domestic customers to approximately 12,000 potential customers globally. In 2016 and 2015, Laboratory Corporation of America, Inc. represented 27% and 17%, respectively, of our total revenue. In 2014, no single customer represented more than 10% of our total revenue.
 
Competition
 
We primarily face competition in the molecular diagnostic testing markets with testing products and systems developed by public and private companies such as bioMerieux (which acquired Biofire Diagnostics, Inc.), Luminex Corporation (which acquired Nanosphere, Inc.), Danaher Corporation (which acquired Cephied), Siemens, Hologic, Inc., Seegene, Roche Diagnostics and Abbott Molecular Diagnostics. Our diagnostic tests also face competition with laboratory developed tests, or LDTs, developed by national and regional reference laboratories and hospitals. We believe that our testing systems compete largely on the basis of accuracy, reliability, enhanced laboratory workflow, multiplex capability, ease-of-use and return on investment for customers.

Many of our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales and distribution organizations than we do. Many of our competitors also offer broader product lines and have greater brand recognition than we do. Moreover, our existing and new competitors may make rapid technological developments that may result in our technologies and products becoming obsolete before we recover the expenses incurred to develop them or before they generate significant revenue.
  
Intellectual Property
 
To establish and protect our proprietary technologies and products, we rely on a combination of our patents, copyrights, trademarks, and trade secrets, as well as other intellectual property rights in our technology and business information. Our intellectual property portfolio for our core electrochemical technology was initially built through the combination of our acquisition of the Clinical Micro Sensors business from Motorola and licensing patents from the California Institute of Technology. We also have exclusively licensed the digital microfluidics technology utilized in our ePlex system within a defined field of use from an affiliate of Illumina.
 
We believe that our patent portfolio, which includes over 100 owned and exclusively licensed U.S. and foreign patents and approximately 30 pending applications, provides us with extensive protection of our eSensor systems. We continue to pursue the issuance of new patents to protect our ongoing research, development and commercial activities, in particular with respect to our ePlex system and related consumables. In general, patents have a term of at least 20 years from the application filing date or earlier claimed priority date. A majority of our issued and exclusively licensed patents are scheduled to expire by 2021, with approximately one half of the patents expiring by 2018. Several of our pending applications have the potential to mature into patents that may expire between 2028 and 2034. Our success depends to a significant degree upon our ability to police infringement and continue to develop proprietary products and technologies without infringing the intellectual property rights of others.
 
We also rely in part on trade secret protection of our intellectual property. We attempt to protect our trade secrets by entering into confidentiality agreements with third parties, employees and consultants. Our employees and consultants also sign agreements requiring that they assign to us their interests in intellectual property, such as patents and copyrights arising from their work for us. All employees sign an agreement not to compete unfairly with us during their employment and upon termination of their employment through the misuse of confidential information.
 
We also have filed for registration, or obtained registration, in the U.S. and other countries for marks used with our products and technology. Our issued trademarks in the United States and/or Europe include eSensor®, word and design marks for GenMark®, GenMark DX®, eSensor®, XT-8®, eSensor XT-8®, ePlex®, and GenMark ePlex®, among others.


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Government Regulation
 
The design, development, manufacture, testing and sale of our molecular diagnostic products are subject to regulation by numerous governmental authorities, principally the FDA, and corresponding state and foreign regulatory agencies.
 
Regulation by the FDA
 
In the United States, the Federal Food, Drug, and Cosmetic Act, or FDCA, FDA regulations and other federal and state statutes and regulations govern, among other things, medical device design and development, preclinical and clinical testing, premarket clearance or approval, registration and listing, manufacturing, labeling, storage, advertising and promotion, sales and distribution, export and import, and post-market surveillance. The FDA regulates the design, manufacturing, servicing, sale and distribution of medical devices, including molecular diagnostic test kits and instrumentation systems. Failure to comply with applicable U.S. requirements may subject a company to a variety of administrative or judicial sanctions, such as FDA refusal to approve pending applications, warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties and criminal prosecution. Unless an exemption applies, each medical device we wish to distribute commercially in the United States will require marketing authorization from the FDA prior to distribution.

The two primary types of FDA marketing authorization required applicable to a device are premarket notification, also called 510(k) clearance, and premarket approval, also called PMA. We have obtained 510(k) clearance from the FDA for the following molecular diagnostic tests for use on our XT-8 system: the Respiratory Viral panel, the eSensor Warfarin Sensitivity Test, the Cystic Fibrosis Genotyping Test, and the Thrombophilia Risk Test. In December 2016, we filed 510(k) applications with the FDA for our ePlex instrument and RP Panel.

Proposed Regulation of Laboratory Developed Tests (LDTs). In October 2014, the FDA promulgated draft guidance which describes a new proposed regulatory framework for LDTs. Based on this proposal, clinical laboratories that develop and use LDTs would be required to comply with specific regulatory requirements (e.g., adverse even reporting, quality system regulation, or QSR, premarket submission, and FDA review) prior to the use of LDTs for clinical diagnostic purposes. The timeline for phasing in the proposed regulatory requirements would begin upon finalization of the FDA guidance document. The ultimate impact of this draft guidance on our customers remains uncertain.
 
Regulation after FDA Clearance or Approval.    Any devices we manufacture or distribute pursuant to clearance or approval by the FDA are subject to pervasive and continuing regulation by the FDA and certain state agencies. We are required to adhere to applicable regulations setting forth detailed Good Manufacturing Practices, or GMP, requirements, as set forth in the QSR, which includes testing, control and documentation requirements. Non-compliance with these standards can result in fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspension of production, refusal of the government to grant 510(k) clearance or PMA of devices, withdrawal of marketing approvals and criminal prosecutions. We have designed and implemented quality system processes within our manufacturing facilities in order to comply with FDA’s GMP requirements.
 
Because we are a medical device manufacturer, we must also comply with FDA’s medical device reporting requirements whenever there is evidence that reasonably suggests that one of our products may have caused or contributed to a death or serious injury. We must also report any incident in which our product has malfunctioned if that malfunction would likely cause or contribute to a death or serious injury if it were to recur.

Labeling, advertising, and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Medical devices approved or cleared by the FDA may not be promoted for unapproved or uncleared uses, otherwise known as “off-label” promotion. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability, including substantial monetary penalties and criminal prosecution. We have implemented quality system processes and advertising/promotional policies designed to comply with these requirements.
 
Environmental Regulations.    We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. Some of these laws require us to obtain licenses or permits to conduct our operations. We have numerous policies and quality system procedures in place to ensure compliance with these laws and to minimize the risk of occupational exposure to hazardous materials. We do not expect the operations of our products to produce significant quantities of hazardous or toxic waste or radiation that would require the use of extraordinary disposal practices. Although the costs to comply with these applicable laws and regulations have not been material, we cannot predict the impact on our business of new or amended laws or regulations or any changes in the way existing and future laws and regulations are interpreted or enforced, nor can we ensure we will be able to obtain or maintain any required licenses or permits.


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Export of Our Products.    Medical devices that are legally marketed in the U.S. may be exported anywhere in the world without prior FDA notification or approval. Devices that have not been approved or cleared in the U.S. must follow the export provisions of the FDCA. Depending on which section of the FDCA we may export under, we may need to request an export permit letter or export certificate, or we may need to submit a simple notification. Export certificates may be requested by foreign customers or foreign governments to provide proof of the products’ status as regulated by the FDA. The export certificate is prepared by the FDA and contains information about a product’s regulatory or marketing status in the United States.
 
Clinical Laboratory Improvement Amendments of 1988.    The use of our products is also affected by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and related federal and state regulations, which provide for regulation of laboratory testing. Any customers using our products for clinical use in the United States will be regulated under CLIA, which establishes quality standards for all laboratory testing to ensure the accuracy, reliability and timeliness of patient test results regardless of where the test was performed. In particular, these regulations mandate that clinical laboratories must be certified by the federal government or a federally approved accreditation agency, or must be located in a state that has been deemed exempt from CLIA requirements because the state has in effect laws that provide for requirements equal to or more stringent than CLIA requirements. Moreover, these laboratories must meet quality assurance, quality control and personnel standards, and they must undergo proficiency testing and inspections. The CLIA standards applicable to clinical laboratories are based on the complexity of the method of testing performed by the laboratory, which range from “waived” to “moderate complexity” to “high complexity.” We expect that most of our products will be categorized as “high complexity,” since most molecular diagnostic tests are currently FDA-cleared as CLIA “high complexity” devices.
 
Foreign Government Regulation.    We intend to market our products in European and other select international markets. The regulatory pre-market requirements for in vitro diagnostic, or IVD, devices vary from country to country. Some countries impose product standards, packaging requirements, labeling requirements and import restrictions on devices. Each country has its own tariff regulations, duties and tax requirements. Failure to comply with applicable foreign regulatory requirements may subject us to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.
 
Fraud and Abuse Regulations
 
We are subject to numerous federal and state health care anti-fraud laws, including the federal anti-kickback statute and False Claims Act, or the FCA, that are intended to reduce waste, fraud and abuse in the health care industry. These laws are broad and subject to evolving interpretations. They prohibit many arrangements and practices that are lawful in industries other than health care, including certain payments for consulting and other personal services, some discounting arrangements, the provision of gifts and business courtesies, the furnishing of free supplies and services, and waivers of payments. In addition, many states have enacted or are considering laws that limit arrangements between medical device manufacturers and physicians and other health care providers and require significant public disclosure concerning permitted arrangements. These laws are vigorously enforced against medical device manufacturers and have resulted in manufacturers paying significant fines and penalties and being subject to stringent corrective action plans and reporting obligations. We must operate our business within the requirements of these laws and, if we were accused of violating them, we could be forced to expend significant resources on investigation, remediation and monetary penalties.
 
Patient Protection and Affordable Care Act
 
Our operations are affected by the federal Patient Protection and Affordable Care Act of 2010, as modified by the Health Care and Education Reconciliation Act of 2010, which we refer to as the Health Care Act. The Health Care Act imposes a 2.3% excise tax on sales of medical devices by manufacturers. In December 2015, the excise tax was suspended for 2016 and 2017. We are unable to predict whether the suspension will be continued beyond 2017. Taxable devices include any medical device defined in section 201(h) of the FDCA and intended for use by humans, with limited exclusions for devices purchased by the general public at retail for individual use. There is no exemption for small companies, and we paid the tax from January 2013 through December 2015. The Health Care Act also requires manufacturers to report to the Department of Health and Human Services detailed information about financial arrangements with physicians and teaching hospitals. These reporting provisions preempt state laws that require reporting of the same information, but not those that require reports of different or additional information. Failure to comply with these requirements subjects the manufacturer to significant civil monetary penalties.
 
Employees
 
As of December 31, 2016, we had 308 employees, of which: 163 employees were involved in research and development; 51 in operations, manufacturing and quality assurance; 62 in sales and marketing; and 32 in general and administrative functions. Our success will depend in large part upon our ability to attract and retain employees. We face competition in this

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regard from other companies, research and academic institutions, government entities and other organizations. None of our employees are covered by a collective bargaining agreement.

Corporate and Available Information
 
Our corporate office is located at 5964 La Place Court, Carlsbad, California. We also lease additional manufacturing space nearby to our corporate office in Carlsbad, California.
 
We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or the SEC. We also make these documents and certain public financial information available on our website, which is www.genmarkdx.com. Our SEC reports and other financial information can be accessed through the investor relations section of our website. Some of the information found on our website is not part of this or any other report we file with or furnish to the SEC.
 
Item 1A.
RISK FACTORS
 
You should consider each of the following factors as well as the other information in this Annual Report in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline. You should also refer to the other information set forth in this Annual Report, including our financial statements and the related notes.

We may be unsuccessful in obtaining FDA clearance for our ePlex system within our expected timeframe.

We are investing significantly in the commercialization of our ePlex instrument and the development of its related molecular diagnostic panels to expand our future product offerings. Our ePlex system requires 510(k) clearance or pre-market approval by the FDA prior to marketing it for clinical use in the United States. In December 2016, we filed 510(k) applications with the FDA for our ePlex instrument and RP Panel. There are a number of potential risks associated with conducting clinical trials and obtaining regulatory clearance for our ePlex system. For example, we may have difficulty maintaining the level of product reliability and clinical accuracy required to obtain FDA clearance or approval for our ePlex system. In addition, the FDA may require that we conduct additional studies that could impact the cost associated with product clearance and could potentially delay commercial launch of our ePlex system in the United States. We may be unsuccessful in obtaining FDA clearance for our ePlex system within our expected timeframe, or at all, which could adversely impact our future financial performance and cause our stock price to decline.

From time to time we and our key suppliers experience, and may in the future experience, difficulties scaling manufacturing operations to the levels required to support our anticipated growth.

To date, we have produced our products in limited quantities relative to the quantities necessary to achieve our desired revenue growth. Developing the necessary manufacturing and quality procedures internally and in conjunction with our key suppliers for a significant number of our newly developed, highly complex products and product components is a challenging process. From time to time we and our suppliers experience, and may in the future experience, manufacturing variability and may not be able to consistently produce sufficient quantities of high quality products and product components at the levels necessary to achieve our revenue growth expectations or to support our product development timelines. If we or our key suppliers continue to encounter difficulties in producing sufficient yields of high quality products or product components, or scaling manufacturing operations as a result of, among other things, process and manufacturing transfer complexities, quality control and quality assurance issues, and/or availability of subcomponents, equipment and raw material supplies, our reputation may be harmed and we may not achieve our anticipated financial results or product development goals within the time frame we expect, or at all. In addition, finding solutions to product quality, reliability, and variability issues is time consuming and expensive, and we may incur significant additional costs or lose revenue as a result of, among other things, delayed product introduction, product recalls, shipment holds, scrapped material, and warranty and service obligations.

To manage our anticipated future growth effectively, we must enhance our manufacturing and supply chain capabilities, infrastructure and operations, information technology infrastructure, and financial and accounting systems and controls. Organizational growth and scale-up of operations could strain our existing managerial, operational, financial and other resources. If our management is unable to effectively prepare for our expected future growth, our expenses may increase more than anticipated, our revenue could grow more slowly than expected, and we may not be able to achieve our commercialization

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or product development goals. Our failure to effectively implement the necessary processes and procedures and otherwise prepare for our anticipated growth could have a material adverse effect on our future financial condition and prospects.

Disruptions in the supply of raw materials, consumable goods or other key product components, or issues associated with their cost or quality from our single source suppliers, could result in delays or difficulties successfully commercializing our ePlex system or a significant disruption in sales and profitability. 

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, acceptable manufacturing costs and complying with regulatory requirements. Our instrument systems and certain critical components are custom-made by only a few outside suppliers. In certain instances, we and our customers have a sole source supply for certain key products, product components and ancillary items used to run our tests. If we are unable to satisfy our forecasted demand from existing suppliers for our products, or we or our customers are unable to find alternative suppliers for key product components or ancillary items at reasonably comparable prices, it could have a material adverse effect on our financial condition and results of operations. Additionally, although we have entered into supply agreements with most of our suppliers of strategic reagents and parts to help ensure component availability and flexible purchasing terms with respect to the purchase of such components, if our suppliers discontinue production of a key component for one or more of our products, we may be unable to identify or secure a viable, cost-effective alternative on reasonable terms, or at all, which could limit our ability to manufacture our products.

In determining the required quantities of our products and the manufacturing schedule, we must make significant judgments and estimates based on seasonality, inventory levels, current market trends and other related factors. Because of the inherent nature of estimates and our limited experience in marketing our products, there could be significant differences between our estimates and the actual amounts of products we require. This can result in shortages if we fail to anticipate demand, or excess inventory and write-offs if we order more than we need.

Reliance on third-party manufacturers entails risk to which we would not be subject if we manufactured these components ourselves, including:

reliance on third parties for regulatory compliance and quality assurance;
possible breaches of manufacturing agreements by the third parties because of factors beyond our control;
possible regulatory violations or manufacturing problems experienced by our suppliers;
possible termination or non-renewal of agreements by third parties, based on their own business priorities, at times that are costly or inconvenient for us;
the potential obsolescence and/or inability of our suppliers to obtain required components;
the potential delays and expenses of seeking alternate sources of supply or manufacturing services;
the inability to qualify alternate sources without impacting performance claims of our products;
reduced control over pricing, quality and timely delivery due to the difficulties in switching to alternate suppliers or assemblers;
the potential for financial hardship or other detrimental circumstances at key suppliers that may impact our ability to source key materials or services required for the manufacturing of our products; and
increases in prices of raw materials and key components.
The manufacturing operations for our test cartridges use highly technical processes involving unique, proprietary techniques. In addition, the manufacturing equipment we use would be costly and time consuming to repair or replace. Any interruption in our operations or decrease in the production capacity of our manufacturing facility or the facilities of any of our key suppliers because of equipment failure, natural disasters such as earthquakes, tornadoes and fires, or otherwise, would limit our ability to meet customer demand for our products and would have a material adverse effect on our business, financial condition and results of operations. 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.

We may not expand sales of our ePlex system outside the United States at the levels we anticipate.

In June 2016, we obtained CE Mark under the European In-Vitro Diagnostic Devices Directive (98/79/EC) for our ePlex instrument and ePlex RP Panel. We are commercializing our ePlex system in Europe utilizing a direct sales and technical support team in certain key European countries, which we have augmented with a third party logistics provider that is responsible for managing the international delivery of our products and providing certain other related services. We have also engaged a number of distributors in certain European countries and intend to further expand internationally over time. If we are

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unable to establish the infrastructure or recruit highly qualified personnel to support our international direct sales and support organization, if we fail to adequately plan for or integrate our direct sales activities with those of our third party logistics provider, or if we are unsuccessful in developing awareness and acceptance of our products and technology internationally, our anticipated revenue growth internationally may not materialize, our customers may not receive the level of service or product dependability they expect from us, and our future financial performance may be adversely affected. Furthermore, any distributors we establish in particular geographic regions may not commit the necessary resources to market and sell our products to meet our expectations. If distributors do not perform adequately or in compliance with applicable laws and regulations in particular geographic areas, or if we are unable to locate distributors in particular geographic areas, our ability to realize revenue growth based on sales outside the United States would be harmed.

Our financial results will depend on the acceptance and increased demand among our target customers and the medical community of our molecular diagnostic technologies and products.

Our future success depends on the belief by our target customers and the medical community that our molecular diagnostic products are a reliable, medically-relevant, accurate and cost-effective replacement for other diagnostic testing methods. Our business success depends on our ability to convince our target customers to perform these tests internally with our products if they have historically outsourced their testing needs or have historically used non-molecular methods to perform such testing, or to replace their current molecular testing platforms with our system and its related test offerings.

Many other factors may affect the market acceptance and commercial success of our molecular diagnostic technology and products, including:

the relative convenience, ease of use, accuracy, reliability, scalability, cost, and time-to-result of our diagnostic products over competing products;
the introduction of new technologies and competing products that may make our technologies and products a less attractive solution for our target customers;
the breadth and relevance of our menu of available diagnostic tests relative to our competitors;
our success in training our customers in the proper use of our products;
the acceptance in the medical community and key opinion leaders of our molecular diagnostic technology and products;
the extent and success of our marketing and sales efforts; and
general economic conditions.
Professional societies, government agencies, practice management groups, private health/science foundations and organizations involved in healthcare issues may publish guidelines, recommendations or studies for the healthcare and patient communities. Recommendations of government agencies or these other organizations may relate to such matters as cost-effectiveness and use of related products. Organizations like these have in the past made recommendations about our competitors’ products, such as the need for less frequent screening tests, which could result in reduced product sales. Moreover, the perception by the investment community or stockholders that recommendations, guidelines or studies will result in decreased use of our products could adversely affect the prevailing market price for our common stock.

We face intense competition from established and new companies in the molecular diagnostics field and expect to face increased competition in the future.
 
The markets for our technologies and products are highly competitive and we expect the intensity of competition to increase. We compete with companies engaged in the development, commercialization and distribution of similar products intended for clinical molecular diagnostic applications. Categories of our competitors include:
 
companies developing and marketing multiplex molecular diagnostics systems, including: Luminex; Nanosphere, Inc. (which was acquired by Luminex in June 2016); bioMerieux (which acquired BioFire Diagnostics, Inc.); Abbott Molecular Diagnostics; Hologic, Inc.; Seegene and Cepheid (which was acquired by Danaher Corporation);
large hospital-based laboratories and reference laboratories who provide large-scale testing using their own proprietary testing methods, including Quest Diagnostics Incorporated and Laboratory Corporation of America; and
companies that manufacture laboratory-based tests and analyzers, including: Cepheid; Siemens; Hologic, Inc.; Qiagen NV; bioMérieux; Roche Diagnostics; and Abbott Molecular Diagnostics.


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Our diagnostic tests also face competition from LDTs developed by national and regional reference laboratories and hospitals. LDTs may not currently be subject to the same regulatory requirements, including those requiring clinical trials and FDA review and clearance or approval that may apply to our diagnostic products.

We anticipate that we will face increased competition in the future as new companies enter the market with new technologies, our competitors improve their current products and expand their menu of diagnostic tests, and as we expand our operations internationally. Many of our current and potential competitors have greater name recognition, more substantial intellectual property portfolios, longer operating histories, significantly greater resources to invest in new technologies, more substantial experience in new product development, greater regulatory expertise, and more extensive manufacturing and distribution capabilities. It is critical to our success that we anticipate changes in technology and customer requirements and successfully introduce enhanced and competitive technology to meet our customers’ and prospective customers’ needs on a timely basis.

Our quarterly revenue and operating results may vary significantly and we may experience constraints or inefficiencies caused by unanticipated acceleration and deceleration of customer demand.

Revenue from our infectious disease products fluctuates based upon the occurrence of related outbreaks and changes in testing recommendations and available therapies. Influenza and other respiratory-related outbreaks are usually more concentrated in the first and fourth quarters of the year. New information or the introduction of advanced treatment options with respect to a particular disease may also affect related diagnostic testing. Although certain infectious disease outbreaks tend to occur each year, the timing, severity and length of these incidents varies from one year to another and can vary across different patient populations. In addition, we may not accurately predict changes to infectious disease testing recommendations affecting our products. As a result of one or more of these factors, we may not be able to accurately forecast sales from our infectious disease products.

Also, unanticipated changes in customer demand for our products may result in constraints or inefficiencies related to our manufacturing, sales force, customer service and administrative infrastructure. These constraints or inefficiencies may adversely affect us as a result of delays, lost potential product sales or loss of current or potential customers due to their dissatisfaction.

Our revenue, results of operations and cash flows would suffer upon the loss of a significant customer.

Our largest customer, Laboratory Corporation of America, Inc., accounted for approximately 27% of our total revenue for the fiscal year ended December 31, 2016. The loss of a significant customer or a significant reduction in the amount of product ordered by our significant customers may adversely affect our revenue, results of operations and cash flows.

We may not be able to correctly estimate or control our future operating expenses, which could lead to cash shortfalls.
 
Our operating expenses may fluctuate significantly in the future as a result of a variety of factors, many of which may be outside of our control. These factors include, but are not limited to:
 
the time and resources required to develop, and conduct clinical studies and obtain regulatory clearances for, our diagnostic tests;
the expenses we incur for research and development required to maintain and improve our technology, including developing our ePlex test menu;
the costs of preparing, filing, prosecuting, defending and enforcing patent claims and other patent related costs, including litigation costs and the results of such litigation;
the expenses we incur in connection with commercialization activities, including product marketing, sales, and distribution expenses;
the expenses we incur in licensing technologies from third parties to expand the menu of diagnostics tests we plan to offer;
our sales strategy and whether the revenues from sales of our test cartridges or systems will be sufficient to offset our expenses;
the costs to attract and retain personnel with the skills required for effective operations; and
the costs associated with being a public company.
Our budgeted expense levels are based in part on our expectations concerning future revenues from sales of our products, as well as our assessment of the future investments needed to expand our commercial organization and support research and development activities in connection with our ePlex system. We may be unable to reduce our expenditures in a

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timely manner to compensate for any unexpected events or a shortfall in revenue. Accordingly, a shortfall in demand for our products or other unexpected events could have an immediate and material impact on our business and financial condition.

Our credit facility requires that we satisfy certain milestones in order to access funding and contains restrictions that limit our flexibility in operating our business.

In January 2015, we entered into a Loan and Security Agreement, or the LSA, with Solar Capital Partners (as successor-in-interest to General Electric Capital Corporation), and certain other lenders. Pursuant to the LSA, as amended, we borrowed $10 million in March 2015 and another $10 million in June 2016. We may borrow up to an additional $15 million if we timely obtain FDA clearance of our ePlex system. In addition, we have access to up to $5 million under a revolving credit facility, subject to certain conditions and a defined borrowing base. If we fail to satisfy the conditions to funding under our credit facility, including, but not limited to, as a result of our failure to timely achieve FDA clearance of our ePlex system, we may not have the ability to borrow additional amounts under our credit facility.

In addition, we must comply with certain affirmative and negative covenants under our credit facility, including covenants that limit or restrict our ability to, among other things:

incur additional indebtedness or issue certain preferred shares;
pay dividends on, repurchase or make distributions in respect of, our capital stock or make other restricted payments;
make certain investments or acquisitions;
sell certain assets;
create liens; or
enter into certain transactions with our affiliates.
 
If we default under the agreement, because of a covenant breach or otherwise, the outstanding amounts thereunder could become immediately due and payable and the lenders could terminate all commitments to extend further financing.

We may need to raise additional funds in the future, and such funds may not be available on a timely basis, or at all.

Until such time, if ever, as we can generate positive cash flows from operations, we will be required to finance our operations with our cash resources and amounts made available under our credit facility. We may need to raise additional funds in the future to support our operations. We cannot be certain that additional capital will be available as needed, on acceptable terms, or at all. If we require additional capital at a time when investment in our company, in molecular diagnostics companies, or the marketplace in general is limited, we may not be able to raise such funds at the time that we desire, or at all. If we do raise additional funds through the issuance of equity or convertible securities, the percentage ownership of holders of our common stock could be significantly diluted. In addition, newly issued securities may have rights, preferences or privileges senior to those of holders of our common stock. If we raise additional funds through collaborations and licensing arrangements, we could be required to relinquish significant rights to our technologies and products, or grant licenses on terms that are not favorable to us.

We have a history of net losses, and we may never achieve or maintain profitability.
 
We have a history of significant net losses and a limited history commercializing our molecular diagnostic products. Our net losses were approximately $50.6 million and $42.2 million for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, we had an accumulated deficit of $355.3 million. We expect to continue to incur significant expenses for the foreseeable future in connection with our ongoing operations, primarily related to expanding our commercial organization (sales and marketing), research and development, manufacturing, clinical and regulatory activities related to our ePlex system, maintaining our existing intellectual property portfolio, obtaining additional intellectual property rights, and investing in corporate infrastructure. We cannot provide any assurance that we will achieve profitability and, even if we achieve profitability, that we will be able to sustain or increase profitability on a quarterly or annual basis. Further, because of our limited commercialization history and the rapidly evolving nature of our target market, we have limited insight into the trends that may emerge and affect our business. We may make errors in predicting and reacting to relevant business trends, which could harm our business and financial condition.

The regulatory clearance or approval process for certain products is expensive, time consuming and uncertain, and the failure to obtain and maintain required clearances or approvals could prevent us from commercializing our products.

The regulatory environment is constantly evolving. For example, the FDA conducted a review of the pre-market clearance process in response to internal and external concerns regarding the 510(k) program and, in January 2011, announced

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25 action items designed to make the process more rigorous and transparent. Some of these proposals, if enacted, could impose additional regulatory requirements for device manufacturers which could delay our ability to obtain new 510(k) clearances, increase the costs of compliance or restrict our ability to maintain our current clearances. Similarly, the European Union, or EU, is proposing to update the European Directive 98/79/EC on in vitro diagnostic medical device, or IVD Directive (IVDD), that could impact the classification of our molecular diagnostic products and result in additional regulatory requirements, which could delay our ability to CE Mark our products. Delays in receipt of, or failure to obtain, clearances or approvals for future products would result in delayed, or no, realization of revenues from such products and in substantial additional costs, which could decrease our profitability.

We must also comply with the applicable FDA and foreign regulatory agency post-market requirements. Any failure to maintain post-market compliance with FDA or foreign regulatory requirements could harm our business, operations, and/or financial condition.

We derive revenues from the sale of research use only, or RUO, tests and custom manufactured reagents, which are not intended for diagnostic purposes. Clinical laboratories are regulated under CLIA and may validate the clinical diagnostic use of an LDT specifically for use in their laboratory using any labeled products. The FDA has traditionally practiced enforcement discretion regarding the use of the LDTs for clinical diagnostic purposes. However, the FDA has recently promulgated draft guidance which outlines stringent regulatory requirements for CLIA labs in order to use LDTs for clinical diagnostic application. These proposed requirements, if implemented, may result in a significant reduction in the sale of our RUO or custom manufactured products, which could reduce our revenues and adversely affect our operations and/or financial condition.

If our products do not perform as expected or the reliability of the technology on which our products are based is questioned, our operating results and business would suffer. 

Our success depends on the market’s confidence that we can provide reliable, high quality, molecular diagnostic products. We believe that customers in our target markets are likely to be particularly sensitive to product defects and errors. As a result, our reputation and the public image of our products and technologies will be significantly impaired if our products fail to perform as expected. Although our diagnostic systems are designed to be user friendly, the functions they perform are complex and our products may develop or contain undetected defects or errors.

We currently manufacture our proprietary test cartridges at our Carlsbad, California manufacturing facilities. We outsource manufacturing of our instruments and much of the disposable component molding for our test cartridges. Leica, the contract manufacturer of our XT-8 instruments, and Plexus Corp., the contract manufacturer of our ePlex instrument, both specialize in the manufacturing of electronic and electro-mechanical devices. While we work closely with Plexus and Leica to ensure continuity of supply while maintaining high quality and reliability, we cannot guarantee that these efforts will be successful.

If we experience a material defect or error in any of our current or future products, it could result in the loss or delay of revenues, increased costs, delayed or reduced market acceptance, damaged reputation, diversion of development and management resources, legal and/or regulatory claims, recalls, increased insurance costs or increased service and warranty costs, any of which could materially harm our business, financial condition and results of operations.

We also face the risk of product liability exposure related to the sale of our products. We currently carry product liability insurance that covers us against specific product liability claims. We also carry a separate general liability and umbrella policy that covers us against certain claims but excludes coverage for product liability. Any claim in excess of our insurance coverage, or for which we do not have insurance coverage, would need to be paid out of our cash reserves, which would harm our financial condition. We cannot assure you that we have obtained sufficient insurance or broad enough coverage to cover potential claims. Also, we cannot assure you that we can or will maintain our insurance policies on commercially acceptable terms, or at all. A product liability claim could significantly harm our business, financial condition and results of operations.

We are subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback, self-referral, false claims and fraud laws, and any violations by us of such laws could result in fines or other penalties.

Our commercial, research and other financial relationships with healthcare providers and institutions are subject to various federal and state laws intended to prevent health care fraud and abuse. The federal anti-kickback statute prohibits the knowing offer, receipt or payment of remuneration in exchange for or to induce the referral of patients or the use of products or services that would be paid for in whole or part by Medicare, Medicaid or other federal health care programs. Remuneration has been broadly defined to include anything of value, including cash, improper discounts, and free or reduced price items and services. Many states have similar laws that apply to their state health care programs as well as private payors. Violations of the anti-kickback laws can result in exclusion from federal health care programs and substantial civil and criminal penalties.

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The FCA imposes liability on persons who, among other things, present or cause to be presented false or fraudulent claims for payment by a federal health care program. The FCA has been used to prosecute persons submitting claims for payment that are inaccurate or fraudulent, that are for services not provided as claimed, or for services that are not medically necessary. We have implemented procedures designed to ensure our compliance with relevant legal requirements. Nevertheless, if our marketing, sales or other arrangements, including our reagent rental arrangements, were determined to violate anti-kickback or related laws, including the FCA, then our revenues could be adversely affected, which would likely harm our business, financial condition and results of operations.

The Health Care Act also imposes reporting and disclosure requirements on device manufacturers for payments to healthcare providers and ownership of their stock by healthcare providers. In February 2013, the Centers for Medicine and Medicaid Services, or, CMS, released the final rule implementing the federal Physician Payments Sunshine Act, or the Sunshine Act. The law requires certain pharmaceutical, biologic, and medical device manufacturers to annually report to CMS payments or other transfers of value they furnish to physicians and teaching hospitals. These reporting requirements took effect on August 1, 2013. Failure to submit required information may result in significant civil monetary penalties. We expect compliance with the PPACA and Sunshine Act to impose significant administrative and financial burdens on us.

In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians for marketing. Some states, such as California, Massachusetts and Vermont, mandate implementation of corporate compliance programs, along with the tracking and reporting of gifts, compensation and other remuneration to physicians. The shifting commercial compliance environment and the need to build and maintain robust and expandable systems to comply with different compliance and/or reporting requirements in multiple jurisdictions increase the possibility that a healthcare company may run afoul of one or more of the requirements.

We are also subject to the U.S. Foreign Corrupt Practices Act, or the FCPA, and other countries’ anti-corruption/anti-bribery regimes, such as the U.K. Bribery Act. The FCPA prohibits improper payments or offers of payments to foreign governments and their officials for the purpose of obtaining or retaining business. Safeguards we implement to discourage improper payments or offers of payments by our employees, consultants, sales agents or distributors may be ineffective, and violations of the FCPA and similar laws may result in severe criminal or civil sanctions, or other liabilities or proceedings against us, any of which would likely harm our reputation, business, financial condition and results of operations.

Legislative or regulatory healthcare reforms may have a material adverse effect on our business and results of operations.

Federal and state governments in the United States are undertaking efforts to control growing health care costs through legislation, regulation and voluntary agreements with medical care providers and third-party payors. In March 2010, Congress enacted the PPACA. While the PPACA involves expanding coverage to more individuals, it includes regulatory mandates and other measures designed to constrain medical costs. Among other requirements, the PPACA imposes a 2.3% excise tax on sales of medical devices by manufacturers. In December 2015, the excise tax was suspended for 2016 and 2017. Taxable devices include any medical device defined in Section 201(h) of the FDCA and intended for use by humans, with limited exclusions for devices purchased by the general public at retail for individual use. There is no exemption for small companies, and we paid the tax from 2013 through 2015. recently, Congress and the new administration have proposed and taken various steps to revise, repeal, or delay implementation of various aspects of PPACA. If the PPACA is significantly revised, repealed, or if implementation of various aspects are delayed, such modification, repeal, or delay may impact our business, financial condition, results of operations, cash flows and the trading price of our securities. Complying with PPACA may significantly increase our tax liabilities and costs, which could adversely affect our business and financial condition.

In August 2011, President Obama signed into law the Budget Control Act of 2011, which among other things, created automatic reductions to several government programs, including aggregate reductions of Medicare payments to providers of up to 2% per fiscal year. In April 2013, the 2% Medicare payment reductions went into effect. In addition to the potential impacts to PPACA under the new administration, there could be sweeping changes to the Budget Control Act and other healthcare reforms. We expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, which could result in reduced demand for our products or additional pricing pressure.


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Our products could infringe patent rights of others, which may require costly litigation and, if we are not successful, could cause us to pay substantial damages or limit our ability to commercialize our products.

Our commercial success depends on our ability to develop, manufacture and market our systems and tests and use our proprietary technology without infringing the patents and other proprietary rights of third parties. As the molecular diagnostics industry expands and more patents are issued, the risk increases that there may be patents issued to third parties that relate to our products and technology of which we are not aware or that we must challenge to continue our operations as currently contemplated. Our products may infringe or may be alleged to infringe these patents.

The patent positions of medical device companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in patents in these fields has emerged to date in the United States or in many foreign jurisdictions. Both the U.S. Supreme Court and the Court of Appeals for the Federal Circuit have made, and will likely continue to make, changes in how the patent laws of the United States are interpreted. For example, three Supreme Court cases, Association for Molecular Pathology et al. v. Myriad Genetics, Inc., et al., Mayo Collaborative Services v. Prometheus Laboratories, and Alice v. CLS Bank, have introduced additional questions regarding the patentability of isolated naturally occurring genes and gene fragments, proteins, peptides, natural products, and related diagnostic and therapeutic methods, which are likely to be resolved only through continued litigation. The overall impact of these decisions and others on the molecular diagnostics industry remains uncertain and our interpretation of the scope of these rulings on existing or future patents may be inaccurate.

There is a significant amount of uncertainty regarding the extent of patent protection and infringement. Companies may have filed pending patent applications that cover technologies we incorporate in our products. As a result, we could be subjected to substantial damages for past infringement or be required to modify our products or stop selling them if it is ultimately determined that our products infringe a third party’s proprietary rights. Even if we are successful in defending against potential intellectual property infringement claims, we could incur substantial costs in doing so. Any litigation related to such claims could consume our resources and lead to significant damages, royalty payments, or an injunction on the sale of certain products. Any additional licenses to patented technology could obligate us to pay substantial additional royalties, which could adversely impact our product costs and harm our business.
 
 If we are unable to obtain, maintain and enforce intellectual property protection covering our products, others may be able to make, use or sell products substantially the same as ours, which could adversely affect our ability to compete in the market. 
 
Our commercial success is dependent in part on obtaining, maintaining and enforcing intellectual property rights, including our patents and other intellectual property rights. If we are unable to obtain, maintain and enforce intellectual property protection covering our products, others may be able to make, use or sell products that are substantially the same as ours without incurring the sizeable development and licensing costs that we have incurred, which would adversely affect our ability to compete in the market.

We seek to obtain and maintain patents and other intellectual property rights to restrict the ability of others to market products that compete with our products. Currently, our patent portfolio is comprised on a worldwide basis of more than 100 owned and exclusively licensed patents and approximately 30 additional pending patent applications. In general, patents have a term of at least 20 years from the application filing date or earlier claimed priority date. A majority of our issued and exclusively licensed patents are scheduled to expire by 2021, with approximately one half of the patents expiring by 2018. Several of our pending applications have the potential to mature into patents that may expire between 2028 and 2034. However, not all of the pending or future patent applications owned by or licensed to us are guaranteed to mature into patents, and, moreover, issued patents owned by or licensed to us now or in the future may be found by a court to be invalid or otherwise unenforceable. Also, even if our patents are determined by a court to be valid and enforceable, they may not be sufficiently broad to prevent others from marketing products similar to ours or designing around our patents, despite our patent rights, nor provide us with freedom to operate unimpeded by the patent rights of others.

We also rely on trade-secret protection to protect our interests in proprietary know-how and for processes for which patents are difficult to obtain or enforce. We may not be able to protect our trade secrets adequately. We have limited control over the protection of trade secrets used by our licensors, collaborators and suppliers. Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third party illegally obtained and is using any of our trade secrets is difficult, expensive and time consuming, and the outcome is unpredictable. We rely, in part, on non-disclosure and confidentiality agreements with our employees, consultants and other parties to protect our trade secrets and other proprietary technology. These agreements may be breached and we may not have adequate remedies for any breach. Moreover, others may independently develop equivalent proprietary information, and third parties may otherwise gain access to

17


our trade secrets and proprietary knowledge. Any disclosure of confidential data into the public domain or to third parties could allow our competitors to learn our trade secrets and use the information in competition against us.

We and our suppliers, contract manufacturers and customers are subject to various governmental regulations, and we may incur significant expenses to comply with, and experience delays in our product commercialization as a result of, these regulations.

Our manufacturing processes and facilities and those of some of our contract manufacturers must comply with the federal Quality System Regulation, or QSR, which covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces the QSR through periodic announced and/or unannounced inspections of manufacturing facilities. We and our contract manufacturers have been, and anticipate in the future being, subject to such inspections, as well as to inspections by other federal and state regulatory agencies.

We must also file reports of device corrections and removals and adhere to the FDA’s rules on labeling and promotion. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability, including substantial monetary penalties and criminal prosecution.

Failure to comply with applicable FDA requirements, or later discovery of previously unknown problems with our products or manufacturing processes, including our failure or the failure of one of our contract manufacturers to take satisfactory corrective action in response to an adverse QSR inspection, can result in, among other things:

administrative or judicially imposed sanctions;
injunctions or the imposition of civil penalties;
recall or seizure of our products;
total or partial suspension of production or distribution;
withdrawal or suspension of marketing clearances or approvals;
clinical holds;
warning letters;
refusal to permit the import or export of our products; and
criminal prosecution.
Any of these actions, in combination or alone, could prevent us from marketing, distributing or selling our products and would likely harm our business.

In addition, a product defect or regulatory violation could lead to a government-mandated or voluntary recall by us. We believe that the FDA would request that we initiate a voluntary recall if a product was defective or presented a risk of injury or gross deception. Regulatory agencies in other countries have similar authority to recall devices because of material deficiencies or defects in design or manufacture that could endanger health. Any recall would divert management attention and financial resources, could cause the price of our common stock to decline and expose us to product liability or other claims, including contractual claims from parties to whom we sold products, and harm our reputation with customers.
The use of our diagnostic products by our customers is also affected by CLIA and related federal and state regulations that provide for regulation of laboratory testing. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating specific standards in the areas of personnel qualifications, administration, participation in proficiency testing, patient test management, quality assurance, quality control and inspections. Current or future CLIA requirements or the promulgation of additional regulations affecting laboratory testing may prevent some laboratories from using some or all of our diagnostic products.

If our customers are not adequately reimbursed or compensated for the use of our products we may have difficulty selling our products.

Our ability to sell our products depends in part on the extent to which reimbursement related to performing tests using our products is available from governmental authorities, such as Medicare and other domestic and foreign governmental programs, private insurance plans, managed care organizations and other organizations. There are ongoing efforts by governmental and third-party payers to contain or reduce the costs of healthcare coverage. In addition, efforts to reform the healthcare delivery system in the United States and Europe has increased pressure on healthcare providers to reduce costs, which has, in turn, increased pressure on medical device manufacturers to decrease prices charged for their products. If

18


purchasers or users of our products are not able to obtain adequate reimbursement for the cost of using our products, either directly or indirectly, they may forego or reduce their purchase and use of our products.

Obtaining coverage and reimbursement approval for a product from each government or third-party payor is a time consuming and costly process that could require us to provide supporting scientific, clinical and cost-effectiveness data for the use of our product to each government or third-party payor. We may not be able to provide data sufficient to gain acceptance with respect to coverage and reimbursement. In addition, eligibility for coverage does not imply that any product will be covered and reimbursed in all cases or reimbursed at a rate that allows our potential customers to make a profit or even cover their costs. Further, third-party payors may choose to reimburse our customers per test based on individual biomarker detection, rather than on the basis of the number of results given by the test. This may result in our customers electing to use separate tests to screen for each disease or condition so that they can receive reimbursement for each test they conduct. In that event, these entities may purchase separate tests for each disease, rather than products, such as ours, that can be used to return highly multiplexed test results.

We are currently reliant on the commercial success of our XT-8 system and its related test menu to partially fund our current operations and ePlex development programs.

We currently market our XT-8 instrument and four FDA-cleared diagnostic tests. In addition, we sell RUO tests and custom manufactured reagents. We have primarily placed our XT-8 systems with customers at no initial charge through reagent rental agreements, under which customers generally commit to purchase minimum quantities of test cartridges and reagents (consumables) over a typical period of one to three years, with a component of the cartridge and reagent price allocated to recover the instrument price. We also offer our XT-8 systems for sale. As a result, to the extent that our XT-8 system and our existing and future products are not commercially successful or are withdrawn from the market for any reason, our operating results, financial condition and critical ePlex development programs would be harmed and we may be required to seek additional funding to support our ongoing operations.

In addition, we have limited marketing, sales and distribution experience and capabilities. Our ability to achieve profitability depends on attracting customers for our products and building brand loyalty. To successfully perform sales, marketing, distribution and customer support functions ourselves, we face a number of risks, including:

our ability to attract and retain the skilled support team, marketing staff and sales force necessary to commercialize and gain market acceptance for our technology and our products;
the ability of our sales and marketing team to identify and penetrate the potential customer base, including hospitals and national and regional reference laboratories; and
the difficulty of establishing brand recognition and loyalty for our products.
Some hospital-based and reference laboratories may not consider adopting our XT-8 system unless we offer a broader menu of diagnostic tests or may choose not to convert from competitive products unless and until we are able to offer a sample-to-answer instrument solution, such as our ePlex instrument. In addition, in order to commercialize our products, we are required to undertake time consuming and costly development activities, including clinical studies for which the outcome is uncertain. Products that appear promising during early development and preclinical studies may, nonetheless, fail to demonstrate the results needed to support regulatory approval or, if approved, may not generate the demand we expect. If we are unable to effectively compete with our XT-8 system and its related test menu, our revenues and our ability to achieve profitability will be significantly impaired.

We incur costs and demands upon management as a result of complying with the laws and regulations affecting public companies in the United States, and failure to comply with these laws could harm our business and the price of our common stock.

As a public company listed in the United States, we incur significant legal, accounting and other expenses. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC, the Public Company Accounting Oversight Board (PCAOB), and The NASDAQ Global Market, may increase our legal and financial compliance costs and make some activities more time consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If we nevertheless fail to comply with new laws, regulations and standards, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
 

19


Economic conditions and an uncertain economic outlook may adversely impact our business, results of operations, financial condition or liquidity.

Global economic conditions may remain challenging and uncertain for the foreseeable future. These conditions may not only limit our access to capital but also make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and they could cause U.S. and foreign businesses and consumers to slow spending on our products and services, which would delay and lengthen sales cycles. Some of our customers rely on government research grants to fund technology purchases. If negative trends in the economy affect the government’s allocation of funds to research, there may be less grant funding available for certain of our customers to purchase technologies from us. Certain of our customers may face challenges gaining timely access to sufficient credit or may otherwise be faced with budget constraints, which could result in decreased purchases of our products or in an impairment of their ability to make timely payments to us. If our customers do not make timely payments to us, we may be required to assume greater credit risk relating to those customers, increase our allowance for doubtful accounts, and our days sales outstanding would be negatively impacted. Although we maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments, we may not continue to experience the same loss rates that we have in the past. Additionally, these economic conditions and market turbulence may also impact our suppliers, causing them to be unable to supply sufficient quantities of customized components in a timely manner, thereby impairing our ability to manufacture on schedule and at commercially reasonable costs.

We are exposed to risks associated with long-lived and intangible assets that may become impaired and result in an impairment charge.

The carrying amounts of long-lived and intangible assets are affected whenever events or changes in circumstances indicate that the carrying amount of any asset may not be recoverable. These events or changes might include an inability to successfully deliver an instrument to the marketplace and attain customer acceptance, a change in the rights or use of licensed intellectual property, adjustments to our depreciation assumptions, or other matters. Adverse events or changes in circumstances may affect the estimated discounted future cash flows expected to be derived from long-lived and intangible assets. If at any time we determine that an impairment has occurred, we will be required to reflect the impaired value as a charge, resulting in a reduction in earnings in the quarter such impairment is identified and a corresponding reduction in our net asset value. In the past we have incurred, and in the future we may incur, impairment charges. A material reduction in earnings resulting from such a charge could cause us to fail to meet the expectations of investors and securities analysts, which could cause the price of our stock to decline.

Providing instrument systems to our customers through reagent rental agreements may harm our liquidity.

Many of our systems are provided to customers via “reagent rental” agreements, under which customers are afforded the right to use the instrument in return for a commitment to purchase minimum quantities of reagents and test cartridges over a period of time. Accordingly, we must either incur the expense of manufacturing instruments well in advance of receiving sufficient revenues from test cartridges to recover our expenses or obtain third party financing sources for the purchase of our instrument. The amount of capital required to provide instrument systems to customers depends on the number of systems placed. Our ability to generate capital to cover these costs depends on the amount of our revenues from sales of reagents and test cartridges sold through our reagent rental agreements. We do not currently sell enough reagents and test cartridges to recover all of our fixed expenses, and therefore we currently have a net loss. If we cannot sell a sufficient number of reagents and test cartridges to offset our fixed expenses, our liquidity will continue to be adversely affected.

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

Our research, product development and manufacturing processes involve the controlled use of hazardous materials, including chemicals, biological materials and infectious disease agents. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resulting 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. Our operations are regulated and may require that environmental permits and approvals be issued by applicable government agencies. 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, clean-up costs or capital expenditures for control equipment or operational changes necessary to achieve and maintain compliance. In addition, we

20


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.

 If we are unable to retain key employees or hire additional skilled employees, we may be unable to achieve our goals. 

Our performance is substantially dependent on the performance of our senior management. Competition for top management personnel is intense and we may not be able to recruit and retain the personnel we need. Our senior managers can terminate their relationship with us at any time. The loss of services of any of these key personnel could significantly reduce our operational effectiveness and investor confidence and our stock price could decline. We do not maintain key-man life insurance on any of our employees. 

In addition, our product development and marketing efforts could be delayed or curtailed if we are unable to attract, train and retain highly skilled technical employees and scientific advisors. To expand our research, product development and commercial efforts, we will need to retain additional people skilled in areas such as electrochemical and molecular science, information technology, manufacturing, sales, marketing and technical support. Because of the complex and technical nature of our systems and the dynamic market in which we compete, any failure to attract and retain a sufficient number of qualified employees could materially harm our ability to develop and commercialize our technology. We may not be successful in hiring or retaining qualified personnel, and any failure to do so could have a material adverse effect on our business, financial condition and results of operations.

Cyberattacks and other security breaches could compromise our proprietary information which could harm our business and reputation.

In the ordinary course of our business, we generate, collect and store proprietary information, including intellectual property and business information. The secure storage, maintenance, and transmission of and access to this information is critical to our operations, business strategy, and reputation. Computer hackers may attempt to penetrate our computer systems or our third party IT service providers' systems and, if successful, misappropriate our proprietary information. In addition, an employee, contractor, or other third-party with whom we do business may attempt to circumvent our security measures in order to obtain such information, and may purposefully or inadvertently cause a breach involving such information. While we will continue to implement additional protective measures to reduce the risk of and detect cyber-attacks, these incidents are becoming more sophisticated and frequent, and the techniques used in such attacks evolve rapidly and are difficult to detect. Despite our cybersecurity measures, our information technology networks and infrastructure may still be vulnerable to unpermitted access by hackers or other breaches, or employee error or malfeasance. Any such compromise of our, or our third party IT service providers' data security and access to, or public disclosure or loss of, confidential business or proprietary intellectual property information could disrupt our operations, damage our reputation, provide our competitors with valuable information, and subject us to additional costs which could adversely affect our business.

Information technology systems implementation issues could disrupt our internal operations and adversely affect our financial results.

Portions of our information technology infrastructure may experience interruptions, delays or cessations of service or produce errors in connection with ongoing systems implementation work. In particular, we have implemented an enterprise resource planning software system. To more fully realize the potential of this system, we are continually reassessing and upgrading processes and this may be more expensive, time consuming and resource intensive than planned. Any disruptions that may occur in the operation of this system or any future systems could increase our expenses and adversely affect our ability to report in an accurate and timely manner the results of our consolidated operations, our financial position and cash flows and to otherwise operate our business in a secure environment, all of which could adversely affect our financial results, stock price and reputation.

Our ability to use our net operating loss carryforwards may be limited.
 
As of December 31, 2016, we had net operating loss, or NOL, carryforwards available of approximately $206.9 million for U.S. federal income tax purposes. These loss carryforwards will expire in varying amounts through 2035. Section 382 of the U.S. Internal Revenue Code of 1986, as amended, or the Code, generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership. We have determined that we have experienced multiple ownership changes under Section 382 of the Code. Our ability to use the current NOL carryforwards may also be limited by the issuance of common stock in the future. To the extent our use of NOL carryforwards is limited, our income may be subject to corporate income tax earlier than it would if we were able to use NOL carryforwards. We have recorded a full valuation allowance against our net deferred tax assets.
 

21


We also had state NOL carryforwards of approximately $165.0 million as of December 31, 2016. We have recorded a full valuation allowance against our net deferred tax assets.

Provisions of our certificate of incorporation, our bylaws and Delaware law could make an acquisition of our Company, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove the current members of our board and management.

Certain provisions of our certificate of incorporation and bylaws could discourage, delay or prevent a merger, acquisition or other change of control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove members of our Board of Directors. These provisions also could limit the price that investors might be willing to pay in the future for our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these transactions may not have the opportunity to do so. These provisions:

allow the authorized number of directors to be changed only by resolution of our Board of Directors;
provide that our stockholders may remove our directors only for cause;
establish a classified board of directors, such that not all members of the Board of Directors may be elected at one time;
authorize our Board of Directors to issue without stockholder approval up to 100,000,000 shares of common stock, that, if issued, would dilute our stock ownership and could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our Board of Directors;
authorize our Board of Directors to issue without stockholder approval up to 5,000,000 shares of preferred stock, the rights of which will be determined at the discretion of the Board of Directors that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our Board of Directors;
require that stockholder actions must be effected at a duly called stockholder meeting or by unanimous written consent;
establish advance notice requirements for stockholder nominations to our Board of Directors or for stockholder proposals that can be acted on at stockholder meetings;
limit who may call stockholder meetings; and
require the approval of the holders of 80% of the outstanding shares of our capital stock entitled to vote in order to amend certain provisions of our certificate of incorporation and bylaws.
In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may, unless certain criteria are met, prohibit large stockholders, in particular those owning 15% or more of the voting rights on our common stock, from merging or combining with us for a prescribed period of time.


Item 1B.
UNRESOLVED STAFF COMMENTS
 
None.
 
Item 2.
PROPERTIES
 
We currently operate from two facilities, each of which is located in Carlsbad, California. We do not own any real property. In February 2010, we entered into a lease for an approximately 31,000 square foot facility in Carlsbad, California, the term of which originally ran through September 2017. The facility is part of a three-building office and research and development project located at 5964 La Place Court, Carlsbad, California. In January 2012, we signed a lease amendment which expanded our executive and administrative office, research and development, and manufacturing space by approximately 22,000 additional square feet and extended the term of the lease through June 2021. In June 2015, we leased an additional 34,000 square feet at a nearby location in Carlsbad, California, which we utilize primarily for ePlex manufacturing operations. The term of the lease runs through September 2023, and we have an option to extend the term of the lease for an additional five years. We believe that our currently leased facilities are adequate to meet our needs for the foreseeable future.
 

22


Item 3.
LEGAL PROCEEDINGS
 
We are from time to time subject to various claims and legal actions in the ordinary course of our business. We believe that there are currently no claims or legal actions that would reasonably be expected to have a material adverse effect on our results of operations or financial condition.
 
Item 4.
MINE SAFETY DISCLOSURES
 
Not applicable.


23


PART II.
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
 
Our common stock has been quoted on The NASDAQ Global Market under the symbol “GNMK” since May 28, 2010. The following table sets forth for the indicated periods the high and low sales prices per share of our common stock as reported on The NASDAQ Global Market.
 
 
High
 
Low
Year Ended December 31, 2016
 
 
 
First Quarter
$
7.73

 
$
4.20

Second Quarter
$
9.48

 
$
5.13

Third Quarter
$
12.17

 
$
8.03

Fourth Quarter
$
13.29

 
$
10.01

Year Ended December 31, 2015
 
 
 
First Quarter
$
14.40

 
$
11.67

Second Quarter
$
13.04

 
$
8.81

Third Quarter
$
10.55

 
$
7.22

Fourth Quarter
$
9.74

 
$
4.63

 
Stock Performance Graph
 
The graph below compares the cumulative total stockholder returns on our common stock for the period indicated with the cumulative total stockholder returns on the NASDAQ Composite Index and the NASDAQ Biotechnology Index for the same period. The graph assumes that $100 was invested on May 28, 2010 in our common stock and in each index and that all dividends were reinvested. No cash dividends have been declared on our common stock. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
 gnmkperformancegraph2016.jpg

24



Stockholders
 
The last reported sale price of our common stock on February 24, 2017 as reported on the NASDAQ Global Market was $11.25. As of February 24, 2017, there were 2,693 holders of record of our common stock.
 
Dividend Policy
 
We have never declared or paid any cash dividends on our common stock and do not expect to pay any dividends for the foreseeable future. In addition, our LSA with Solar Capital Partners contains a negative covenant which may limit our ability to pay dividends. We currently intend to retain any future earnings to fund the operation, development and expansion of our business. Any future determination to pay dividends will be at the sole discretion of our Board of Directors and will depend upon a number of factors, including our results of operations, capital requirements, financial condition, future prospects, contractual arrangements, restrictions imposed by applicable law, any limitations on payments of dividends present in our current and future debt arrangements, and other factors our Board of Directors may deem relevant.
 
Item 6.
SELECTED CONSOLIDATED FINANCIAL DATA
 
The following selected consolidated financial data relates to GenMark Diagnostics, Inc. and its consolidated subsidiaries. The selected consolidated statement of net loss data presented below of GenMark Diagnostics, Inc. for the years ended December 31, 2016, 2015, and 2014 and the selected consolidated balance sheet data of GenMark Diagnostics, Inc. as of December 31, 2016, and 2015 have been derived from the audited consolidated financial statements of GenMark Diagnostics, Inc., which have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, included elsewhere in this Annual Report. The selected consolidated statement of comprehensive loss data presented for the years ended December 31, 2013 and 2012 and the selected consolidated balance sheet data as of December 31, 2014, 2013, and 2012 have been derived from audited financial statements not included in this Annual Report.

The results for the periods shown below are not necessarily indicative of the results to be expected for any future periods. The selected consolidated financial data should be read together with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and with the consolidated financial statements and condensed consolidated financial statements of GenMark Diagnostics, Inc. and related notes included elsewhere in this Annual Report.

25


FIVE YEAR SELECTED FINANCIAL DATA
 
Years ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
Consolidated Statements of Net Loss Data:
(In thousands, except per share data)
Revenue
 
 
 
 
 
 
 
 
 
Product revenue
$
48,914

 
$
39,029

 
$
30,328

 
$
27,204

 
$
20,211

License and other revenue
360

 
382

 
266

 
200

 
258

Total revenue
49,274

 
39,411

 
30,594

 
27,404

 
20,469

Cost of revenue
19,700

 
15,317

 
13,127

 
15,570

 
11,640

Gross profit
29,574

 
24,094

 
17,467

 
11,834

 
8,829

Operating expenses
 
 
 
 
 
 
 
 
 
Sales and marketing
14,734

 
14,385

 
12,629

 
12,818

 
6,378

General and administrative
14,363

 
13,772

 
12,069

 
11,836

 
10,806

Research and development
49,458

 
37,472

 
31,823

 
22,060

 
13,536

Total operating expenses
78,555

 
65,629

 
56,521

 
46,714

 
30,720

Loss from operations
(48,981
)
 
(41,535
)
 
(39,054
)
 
(34,880
)
 
(21,891
)
Other income (expense):
 
 
 
 
 
 
 
 
 
Interest income (expense), net
(1,360
)
 
(755
)
 
224

 
384

 
(48
)
Other income (expense)
(160
)
 
133

 
(6
)
 
897

 
(16
)
Total other income (expense)
(1,520
)
 
(622
)
 
218

 
1,281


(64
)
Loss before income taxes
(50,501
)
 
(42,157
)
 
(38,836
)
 
(33,599
)
 
(21,955
)
Income tax expense (benefit)
100

 
40

 
(573
)
 
44

 
148

Net loss
$
(50,601
)
 
$
(42,197
)
 
$
(38,263
)
 
$
(33,643
)
 
$
(22,103
)
Net loss per share, basic and diluted
$
(1.15
)
 
$
(1.00
)
 
$
(0.93
)
 
$
(0.95
)
 
$
(0.84
)
Weighted average number of shares outstanding, basic and diluted
44,100

 
42,157

 
41,346

 
35,253

 
26,215

 
 
 
 
 
 
 
 
 
 
 
As of December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents and marketable securities(1)(2)(3)
$
41,566

 
$
45,465

 
$
70,506

 
$
105,589

 
$
51,250

Total assets
80,324

 
70,667

 
91,970

 
121,754

 
68,016

Long-term liabilities
15,752

 
11,481

 
1,653

 
2,349

 
2,392

Total liabilities
42,173

 
22,070

 
13,946

 
12,586

 
11,566

Accumulated deficit
(355,270
)
 
(304,669
)
 
(262,472
)
 
(224,209
)
 
(190,566
)
Total stockholders’ equity (1)(2)(3)
38,151

 
48,597

 
78,024

 
109,168

 
56,450

 _____________________
(1)
In August and September 2016, we issued approximately 8.3 million shares of common stock at an average price of $9.04 per share. We raised approximately $29.1 million in net proceeds.
(2)
In August 2013, we issued approximately 8.7 million shares of common stock at a price of $9.84 per share. We raised approximately $81.0 million in net proceeds.
(3)
In June 2012, we issued approximately 11.5 million shares of common stock at a price of $4.20 per share. We raised approximately $45.1 million in net proceeds.


26


Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following in conjunction with the “Selected Consolidated Financial Data” and the consolidated financial statements of GenMark and the related notes thereto that appear elsewhere in this Annual Report. In addition to historical information, the following discussion and analysis includes forward looking information that involves risks, uncertainties and assumptions. Actual results and the timing of events could differ materially from those anticipated by these forward looking statements as a result of many factors, including those discussed under the heading “Risk Factors” included elsewhere in this Annual Report. See also “Forward Looking Statements” included elsewhere in this filing.
 
Overview
 
GenMark was formed by Osmetech ptc, or Osmetech, as a Delaware corporation in February 2010, and had no operations prior to its initial public offering, which was completed in June 2010. Immediately prior to the closing of the initial public offering, GenMark acquired all of the outstanding ordinary shares of Osmetech in a reorganization under the applicable laws of the United Kingdom. Following the reorganization, Osmetech became a wholly-owned subsidiary controlled by GenMark, and the former shareholders of Osmetech received shares of GenMark. Any historical discussion of GenMark relates to Osmetech and its consolidated subsidiaries prior to the reorganization. In September 2012, GenMark placed Osmetech into liquidation to simplify its corporate structure. The liquidation of Osmetech was competed in the fourth quarter of 2013.
 
We are a molecular diagnostics company focused on developing and commercializing multiplex molecular tests that aid in the diagnosis of complex medical conditions and help guide therapy decisions. We currently develop and commercialize high-value, simple to perform, clinically relevant multiplex molecular tests based on our proprietary eSensor electrochemical detection technology.

 Since inception, we have incurred net losses from operations each year, and we expect to continue to incur losses for the foreseeable future. Our net losses for the years ended December 31, 2016, 2015, and 2014 were approximately $50.6 million, $42.2 million, and $38.3 million, respectively. As of December 31, 2016, we had an accumulated deficit of $355.3 million. Our operations to date have been funded principally through sales of capital stock, borrowings, and cash from operations. We expect to incur increasing expenses over the next several years, principally to develop and commercialize our ePlex system and additional diagnostic tests, as well as to further increase our manufacturing capabilities and domestic and international commercial organization.

Our Products and Technology
 
We offer four FDA-cleared diagnostic tests which run on our XT-8 instrument: our Respiratory Viral Panel; our Cystic Fibrosis Genotyping Test; our Warfarin Sensitivity Test; and our Thrombophilia Risk Test. We also offer an HCV genotyping test and associated custom manufactured reagents, as well as a 2C19 Genotyping Test, versions of which are available for use with our XT-8 instrument for research use only (RUO).

In addition, we have commercially launched in Europe our sample-to-answer ePlex instrument and RP Panel, which integrates automated nucleic acid extraction and amplification with our eSensor detection technology to enable operators using ePlex to place a raw or a minimally prepared patient sample directly into our test cartridge and obtain results without any additional steps. This sample-to-answer capability is enabled by the robust nature of our eSensor detection technology, which is not impacted to the same degree by sample impurities that we believe hinder competing technologies. We have designed our ePlex system to further simplify workflow and provide powerful, cost-effective molecular diagnostics solutions to a significantly expanded group of hospitals and reference laboratories. We obtained CE Mark for our ePlex system and RP Panel in June 2016, and filed 510(k) applications with the FDA for the ePlex instrument and RP Panel in December 2016. During 2017, we intend to complete the development of, CE Mark, and submit 510(k) applications to the FDA our ePlex blood culture identification (BCID) family of panels, which include a gram-positive (GP), a gram-negative (GN), and a fungal pathogen panel.  In addition, we are actively evaluating the development of additional assay panels that we believe will meet important, unmet clinical needs, which our ePlex system is uniquely positioned to address.

Revenue
 
Revenue from operations includes product sales, principally of our diagnostic tests. We primarily place our instruments with customers through a reagent rental agreement, under which we retain title to the instrument and customers commit to purchasing minimum quantities of reagents and test cartridges over a period of one to three years. We also offer our instruments for sale.
 

27


Cost of Revenues
 
Cost of revenues includes the cost of materials, direct labor and manufacturing overhead costs used in the manufacture of our consumable tests, including royalties on product sales. Cost of revenues also includes depreciation on revenue generating instruments that have been placed with our customers under a reagent rental agreement, cost of instruments sold to customers, amortization of licenses related to our products and other costs such as warranty, royalty and customer and product technical support. We manufacture our test cartridges in our facility and have recently invested in significant capacity for expansion. Any potential underutilized capacity may result in a high cost of revenues relative to revenue, if manufacturing volumes are not able to fully absorb operating costs. Our instruments are procured from contract manufacturers. We expect our cost of revenues to increase as we place additional instruments and manufacture and sell additional diagnostic tests; however, we expect gross margins related to our products will increase as production volumes, manufacturing efficiencies, improved procurement practices, instrument reliability increases and other improvements decrease costs as a percentage of sales.

Sales and Marketing Expenses
 
Sales and marketing expenses include costs associated with our direct sales force, sales management, marketing, technical support and business development activities. These expenses primarily consist of salaries, commissions, benefits, stock-based compensation, travel, advertising, promotions, product samples and trade show expenses. We expect sales and marketing expenses to increase as we increase our domestic and international commercial efforts to expand our customer base.
 
Research and Development Expenses
 
Research and development expenses primarily include costs associated with the development of our ePlex instrument and its test menu. These expenses also include certain clinical study expenses incurred in preparation for FDA clearance for these products, intellectual property prosecution and maintenance costs, and quality assurance expenses. The expenses primarily consist of salaries, benefits, stock-based compensation, outside design and consulting services, laboratory supplies and equipment, costs of consumables and materials used in product development, contract research organization costs, clinical studies and facility costs. We expense all research and development costs in the periods in which they are incurred.
 
General and Administrative Expenses
 
Our general and administrative expenses include expenses related to our executive, accounting and finance, compliance, information technology, legal, facilities, human resource, administrative and investor relations activities. These expenses consist primarily of salaries, benefits, stock-based compensation costs, independent auditor costs, legal and consulting fees, and travel, insurance, and public company expenses, such as stock transfer agent fees and listing fees for NASDAQ.

Foreign Exchange Gains and Losses
 
Transactions in currencies other than our functional currency are translated at the prevailing rates on the dates of the applicable transaction. Foreign exchange gains and losses arise from differences in exchange rates during the period between the date a transaction denominated in a foreign currency is consummated and the date on which it is settled or translated.
 
Interest Income and Interest Expense
 
Interest income includes interest earned on our cash and cash equivalents and investments. Interest expense represents interest incurred on our loan payable and on other liabilities.
 
Provision for Income Taxes
 
We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If it is more likely than not that we will not recover our deferred tax assets, we will increase our provision for income taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable.

Our income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The

28


first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While we believe we have appropriate support for the positions taken on our tax returns, we regularly assess the potential outcomes of examinations by tax authorities in determining the adequacy of our provision for income taxes. We continually assess the likelihood and amount of potential adjustments and adjust the income tax provision, income taxes payable, and deferred taxes in the period in which the facts that give rise to a revision become known.

Critical Accounting Policies and Significant Judgments and Estimates
 
Revenue
 
We recognize revenue from product sales and contractual arrangements, net of discounts and sales related taxes. We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured. Where applicable, all revenue is stated net of sales taxes and trade discounts. Revenue related to royalties received from licenses is generally recognized evenly over the contractual period to which the license relates. In those cases where we bill shipping and handling costs to customers, the amounts billed are classified as other revenue.
 
We offer customers the choice to either purchase an instrument outright or to receive possession of an instrument free of charge in exchange for a commitment to purchase an annual minimum amount of molecular diagnostic test cartridges.
 
When an instrument is sold, revenue is generally recognized upon shipment of the unit consistent with contract terms. When an instrument is placed free of charge under a "reagent rental" agreement, we retain title to the instrument and it remains capitalized on our balance sheet under property and equipment. Under our reagent rental agreements, our customers pay an instrument usage fee, which is included in the price of each test cartridge purchased. Our reagents and diagnostic test cartridges (consumables) are priced to include the expense of instrument usage and maintenance and are included in product revenue in our consolidated financial statements.
 
We sell our durable instruments and disposable test cartridges through a direct sales force in the United States and certain European countries and through distributor arrangements in other European jurisdictions. The instrument price is not dependent upon the purchase of any amount of disposable test cartridges. Revenue on instrument and test cartridge sales is generally recognized upon shipment consistent with contract terms, which is when title and the risk of loss and rewards of ownership have been transferred to the customer and there are no other post-shipment obligations.

 Allowance for Doubtful Accounts Receivable

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts, the aging of accounts receivable, and the general condition of the economy. Changes in our allowance for doubtful accounts are charged to sales and marketing expense.

Inventory

We value inventories at the lower of cost or net realizable value on a part-by-part basis and provide an inventory reserve for estimated obsolescence and excess inventory based upon historical turnover and assumptions about future demand for our products and market conditions. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, which is generally 12 months. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our actual demand is less than our forecast demand, we may be required to take additional excess inventory charges, which would decrease gross margin and adversely impact net operating results in the future.

Property and Equipment — net
 
Property, equipment and leasehold improvements are recorded at cost and depreciated using the straight-line method over the assets’ estimated useful lives, which are noted below. Each category of property and equipment is analyzed to determine its useful life. We look at the manufacturers’ estimates of useful life and adjust these for actual experience in our operating environment. Useful lives are reviewed periodically and occasionally changed as circumstances dictate.
 

29


Machinery and laboratory equipment
3 - 5 years
Instruments
4 - 5 years
Office equipment
3 - 7 years
Leasehold improvements
over the shorter of the remaining life of the lease or the useful economic life of the asset
Repair and maintenance costs are expensed as incurred. During 2016, 2015 and 2014, we disposed of certain assets no longer in use with a net book value of $76,000, $153,000 and $102,000, respectively, recorded to cost of revenue, sales and marketing, research and development, or general and administrative expenses based on the asset's respective use.
 
Impairment of Long-Lived Assets
 
We assess the recoverability of long-lived assets, including intangible assets and instruments at customer locations by periodically evaluating the carrying value of such assets whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. If impairment is indicated, we write down the carrying value of the asset to the estimated fair value.
 
Stock-Based Compensation
 
We generally grant employees and non-employee directors stock-based awards, which typically comprise stock options, restricted stock units, and/or market-based stock units, in connection with their employment or service. We grant stock options with an exercise price equal to the closing price of our common stock on the NASDAQ Global Market on the applicable grant date. We use the Black-Scholes option-pricing model as the method for determining the estimated fair value of stock options, the Monte Carlo Simulation Valuation Model as the method for determining the estimated fair value of our market-based stock units, and we use the grant date fair value of our common stock for valuing restricted stock awards and units. The estimated fair value of stock-based awards exchanged for employee and non-employee director services are expensed over the requisite service period. The stock-based compensation expense related to shares issued under our 2013 Employee Stock Purchase Plan, or ESPP, is also estimated using the Black-Scholes option-pricing model. These models require the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the stock award's expected term and the price volatility of the underlying stock. These assumptions include:
 
Expected Term.    The expected term represents the period that our stock-based awards are expected to be outstanding and is determined by using the simplified method.
Expected Volatility.    Expected volatility represents the expected volatility in our stock price over the expected term of the stock option or award.
Expected Dividend.    The pricing models require a single expected dividend yield as an input. We assumed no dividends as we have never paid dividends and have no plans to do so.
Risk-Free Interest Rate.    The risk-free interest rates used in the models is based on published government rates in effect at the time of grant for periods corresponding with the expected term of the option or award.
Income Taxes

Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We file income tax returns in the United States, Switzerland, Germany, the United Kingdom, France, and various state jurisdictions. Significant judgments and estimates are required in determining our consolidated income tax expense.
 
We believe that it is more likely than not that the benefit from our deferred tax assets will not be realized. In recognition of this risk, we have provided a full valuation allowance on the net deferred tax assets relating to our net operating loss carryforwards and other deferred tax assets. If our assumptions change and we determine that we will be able to realize our deferred tax assets, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets will be accounted for as a reduction of income tax expense.
 
Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. We are not aware of any such changes that would have a material effect on our results of operations, cash flows or financial position.
 
We recognize tax liabilities in accordance with Accounting Standards Codification, or ASC, Topic 740 and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from

30


our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.
 
Recent Accounting Pronouncements
 
For a summary of recent accounting pronouncements applicable to our consolidated financial statements see Note 2, "Summary of Significant Accounting Policies and Significant Accounts" to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report.

Results of Operations

Comparison of Years Ended December 31, 2016, 2015 and 2014 (tables in thousands):  
 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Revenue
$
49,274

 
$
39,411

 
$
30,594

 
$
9,863

 
25
%
 
$
8,817

 
29
%
 
Our revenue consists primarily of revenue from the sale of test cartridges and reagents (consumables), with a small component from our sale of instruments and other revenue.

For the year ended December 31, 2016, our revenue grew 25%, or $9,863,000, compared to 2015. Consumables revenue during the year ended December 31, 2016 increased by 23% to $46,946,000, compared to $38,061,000 in the prior year. This increase in consumable revenue was primarily driven by increased product purchases by several key customers. Pricing changes did not have a significant impact on revenue during the current period. Additionally, during the year ended December 31, 2016, instrument revenue increased $957,000 compared to the same period of the prior year, primarily due to the sale of ePlex instruments.

For the year ended December 31, 2015, our revenue grew 29%, or $8,817,000, compared to 2014. Consumables revenue during the year ended December 31, 2015 increased by 30% to $38,061,000 compared to $29,235,000 in the prior year. This increase in consumable revenue was primarily driven by increases in our installed base of XT-8 analyzers over the prior year period. Pricing changes did not have an impact on revenue during 2015.

 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Cost of Revenue
$
19,700

 
$
15,317

 
$
13,127

 
$
4,383

 
29
%
 
$
2,190

 
17
%
Gross Profit
$
29,574

 
$
24,094

 
$
17,467

 
$
5,480

 
23
%
 
$
6,627

 
38
%
 
The increase in cost of revenue for the twelve months ended December 31, 2016 compared to the twelve months ended December 31, 2015 was primarily related to the increase in consumables revenue in the current year. Increases in our cost of revenue were attributable to product costs of $3,177,000, increased product warranty and support expenses of $519,000, and increased royalty expense of $431,000 corresponding to sales volume increases, less favorable manufacturing yields and variances of $235,000, and increased overhead expenses of $412,000, partially offset by decreased inventory reserve expense of $387,000. The improvement to gross profit during the year ended December 31, 2016, compared to December 31, 2015, was primarily due to increased sales of higher margin products.

The increase in cost of revenue for the twelve months ended December 31, 2015 compared to the twelve months ended December 31, 2014 was primarily related to the increase in consumables revenue during 2015. Increases in our cost of revenue in 2015 were attributable to product costs of $2,548,000 corresponding to sales volume increases, the expansion of our customer technical support group of $200,000, increased warranty reserve of $144,000, and increased royalty expense of $138,000, partially offset by greater manufacturing efficiencies of $761,000. The improvement to gross profit during the year ended December 31, 2015, compared to December 31, 2014, was primarily due to increased sales of higher margin products and a reduction in manufacturing personnel costs.
 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Sales and Marketing
$
14,734

 
$
14,385

 
$
12,629

 
$
349

 
2
%
 
$
1,756

 
14
%
 

31


Sales and marketing expenses primarily comprise employee-related expenses for our domestic and international commercial organization, and marketing communication and trade show expenses. The increase in sales and marketing expense for the year ended December 31, 2016, compared to the year ended December 31, 2015, was primarily driven by increased marketing and trade show expense of $582,000, increased freight and postage expense of $184,000, and increased travel expenses of $112,000 incurred in connection with expanding our domestic and international commercial organization, partially offset by a decrease in employee-related expenses of $522,000.

The increase in sales and marketing expense for the year ended December 31, 2015, compared to the year ended December 31, 2014, was primarily driven by a $1,747,000 increase in employee-related expenses, including increased stock-based compensation expense of $1,187,000, incurred in connection with expanding our domestic and international commercial organization.
 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
General and Administrative
$
14,363

 
$
13,772

 
$
12,069

 
$
591

 
4
%
 
$
1,703

 
14
%
 
The increase in general and administrative expense for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily driven by an increase in employee-related expenses of $536,000, an adjustment to our indirect tax accrual of $274,00, and an increase in travel-related expenses of $168,000, partially offset by a decrease in medical device tax expense of $447,000 as a result of the suspension of the excise tax in December 2015.

The increase in general and administrative expense for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily due to increased employee-related expenses of $1,966,000, including increased stock-based compensation expense of $1,559,000, and increased medical device tax of $447,000 as a result of higher product sales, partially offset by a $138,000 decrease in consultant and outside service costs and decreased legal expenses of $77,000.
 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Research and Development
$
49,458

 
$
37,472

 
$
31,823

 
$
11,986

 
32
%
 
$
5,649

 
18
%
 
The increase in research and development expense for the year ended December 31, 2016, compared to the year ended December 31, 2015, was primarily driven by increased materials, equipment and consumables used in the development and expansion of our ePlex test menu totaling $10,523,000, increased employee-related expenses of $2,993,000, and increased clinical trials expense of $887,000, partially offset by reduced outside services expenditures of $3,420,000.

The increase in research and development expense for the year ended December 31, 2015, compared to the year ended December 31, 2014, was primarily due to increased ePlex assay development expenses of $3,993,000, increased clinical trials and quality assurance expenses of $897,000, and an increase in ePlex instrument expenses of $663,000. Overall increases in research and development expenses were attributable to employee-related expenses, clinical trials expenses, and supplies and other materials to support our ePlex system and its related test menu.
 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Other Income (Expense)
$
(1,520
)
 
$
(622
)
 
$
218

 
$
(898
)
 
144
%
 
$
(840
)
 
(385
)%
 
Other income (expense) represents non-operating income and expense, including, but not limited to, earnings on cash, cash equivalents, marketable securities, and interest expense related to debt. The change in other income (expense) for the year ended December 31, 2016, compared to the year ended December 31, 2015, was due primarily to an increase in interest expense of $655,000 under our debt facility, and a decrease in income as a result of less interest earned on marketable securities of $217,000 in the current period.

The change in other income (expense) for the year ended December 31, 2015, compared to the year ended December 31, 2014, was due primarily to an increase in interest expense of $860,000 under our debt facility, a decrease in income as a result of less interest earned on marketable securities of $119,000, and an $84,000 increase in unrealized foreign currency losses as a result of our expanding international operations, partially offset by income from a one-time payment of $223,000 received from the release of escrowed proceeds related to our sale of a preferred stock investment in the fourth quarter of 2014.

32


 
Years ended December 31,
 
2016 vs 2015
 
2015 vs 2014
 
2016
 
2015
 
2014
 
$ Change
 
% Change
 
$ Change
 
% Change
Income Tax Expense (Benefit)
$
100

 
$
40

 
$
(573
)
 
$
60

 
150
%
 
$
613

 
107
%
 
Due to net losses incurred domestically, the tax provisions recorded relate to minimum tax payments in the United States. We have recorded tax liabilities related to income earned in local jurisdictions by our foreign subsidiaries. The increase in income tax expense for the year ended December 31, 2016, compared to the year ended December 31, 2015, was primarily a result of international income taxes. The increase in income tax expense for the year ended December 31, 2015 was primarily due to the expiration of the statue of limitations on uncertain tax positions resulting in the recognition of a $610,000 tax benefit in 2014.

Liquidity and Capital Resources
 
To date we have funded our operations primarily from the sale of our common stock, borrowings and cash from operations. We have incurred net losses from operations each year and have not yet achieved profitability. At December 31, 2016, we had $32,028,000 of working capital, including $41,566,000 in cash, cash equivalents, and marketable securities.
 
Cash Flows
 
The following table shows cash flow information for the years ended December 31, 2016, 2015 and 2014:
 
 
Years Ended December 31,
 
2016
 
2015
 
2014
Cash used in operating activities
$
(35,637
)
 
$
(31,915
)
 
$
(29,572
)
Cash provided by (used in) investing activities
(24,123
)
 
19,321

 
29,417

Cash provided by financing activities
40,359

 
11,133

 
1,287

Effect of exchange rate changes on cash
(25
)
 
(9
)
 

Net increase (decrease) in cash and cash equivalents
$
(19,426
)
 
$
(1,470
)
 
$
1,132

 
Cash flows used in operating activities
 
Net cash used in operating activities increased $3,722,000 to $35,637,000 for the year ended December 31, 2016, compared to $31,915,000 for the year ended December 31, 2015. The increase in cash used in operating activities was primarily due to an $8,404,000 increase in our net loss and $535,000 in lower non-cash charges primarily comprised of stock-based compensation expense, partially offset by an additional $5,217,000 cash inflow from changes in operating assets and liabilities. The main drivers in the change in operating assets and liabilities included increases in accounts payable, accrued compensation and other liabilities and increases in inventory and accounts receivable.

Net cash used in operating activities increased $2,343,000 to $31,915,000 for the year ended December 31, 2015, compared to $29,572,000 for the year ended December 31, 2014. The increase in cash used in operating activities was primarily due to a $3,934,000 increase in net loss and $4,658,000 in lower non-cash charges primarily related to less bad debt expense and impairment, partially offset by $3,067,000 of less cash outflow from changes in operating assets and liabilities.
 
Cash flows provided by (used in) investing activities
 
Net cash used in investing activities for the year ended December 31, 2016, compared to the year ended December 31, 2015, increased $43,444,000 primarily due to a $36,000,000 decrease from the maturity of short-term marketable securities, an increase in purchases of marketable securities of $11,042,000, and increased purchase of property, plant, equipment and licenses of $4,194,000, partially offset by a $7,792,000 increase in proceeds from the sale of marketable securities.

Net cash provided by investing activities for the year ended December 31, 2015, compared to the year ended December 31, 2014, decreased $10,096,000 primarily due to a $10,000,000 decrease from the maturity of short-term marketable securities and a $7,274,000 decrease in proceeds from the sale of marketable securities related to our sale of a preferred stock investment, partially offset by a decrease in purchases of marketable securities of $5,408,000.

Cash flows provided by financing activities
 
Net cash provided by financing activities increased $29,226,000 to $40,359,000 for the year ended December 31, 2016, compared to $11,133,000 for the year ended December 31, 2015, primarily due to a $28,893,000 increase in net proceeds

33


generated from from an at-the-market equity offering described in greater detail below, and an absence of debt issuance costs of $628,000 incurred in the prior year, partially offset by a decrease in proceeds from the exercise of employee stock options of $277,000.

Net cash provided by financing activities increased $9,846,000 to $11,133,000 for the year ended December 31, 2015, compared to $1,287,000 for the year ended December 31, 2014, primarily due to the borrowing of $10,000,000 under our debt facility and $458,000 in higher proceeds from stock option exercises, partially offset by $718,000 in costs associated with debt issuance.

We have prepared cash flow forecasts which indicate, based on our current cash resources available, that we will have sufficient resources to fund our business for at least the next 12 months. We expect capital outlays and operating expenditures to increase over the next several years as we grow our customer base and revenues, and expand our research and development, commercialization and manufacturing activities. Factors that could affect our capital requirements, in addition to those previously identified, include, but are not limited to:
 
the level of revenues and the rate of our revenue growth;
change in demand from our customers;
the level of expenses required to expand our commercial (sales and marketing) and manufacturing activities;
the level of research and development investment required to develop our diagnostic systems and test menu;
our need to acquire or license complementary technologies;
the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;
competing technological and market developments; and
changes in regulatory policies or laws that affect our operations.
Loan and Security Agreement

In January 2015, we entered into a Loan and Security Agreement, of the LSA, with Solar Capital Partners (as successor-in-interest to General Electric Capital Corporation), and certain other financial institutions party thereto, as lenders, pursuant to which we obtained (a) up to $35,000,000 in a series of term loans and (b) a revolving loan in the maximum amount of $5,000,000.  Under the terms of the LSA, as amended, we could, subject to certain conditions, borrow:

$10,000,000 (Term Loan A) on or before March 31, 2015, which we borrowed in March 2015;
an additional $10,000,000 (Term Loan B), subject to our satisfaction of regulatory requirements necessary to CE Mark our ePlex system in Europe by a specified date, which we borrowed in June 2016;
an additional $15,000,000 (Term Loan C), subject to our satisfaction of FDA 510(k) market clearance for the sale of our ePlex system in the United States by a specified date; and
up to $5,000,000 in the form of a revolving loan, which is subject to a defined borrowing base as set forth in the LSA.    
In July 2016, we entered into an amendment to the LSA pursuant to which the lenders internally reallocated certain funding commitments under the LSA between the lenders, and the parties extended the date by which the future funding requirements in respect of Term Loan C must be satisfied.

In February 2017, we entered into an amendment to the LSA pursuant to which the parties further extended the date by which the future funding requirements in respect of Term Loan C must be satisfied. In addition, the parties agreed to extend the interest-only period in respect of amounts already borrowed under Term Loan A and Term Loan B, as well as the amounts, if any, we may borrow pursuant to Term Loan C.

Pursuant to the terms of the LSA, the lenders are granted a security interest in (a) all of our personal property, other than intellectual property (which is subject to a negative pledge), but including our rights to payment in respect of intellectual property, (b) the stock of all of our domestic subsidiaries, and (c) 65% of the voting stock and 100% of the non-voting stock of each of our non-U.S. subsidiaries.

The LSA contains customary affirmative and negative covenants, including, without limitation, delivering reports and notices relating to our financial condition and certain regulatory events and intellectual property matters, as well as limiting the

34


creation of liens, the incurrence of indebtedness, and the making of certain investments, payments and acquisitions, other than as specifically permitted by the LSA.

Equity Distribution Agreement

On June 14, 2016, we entered into an Equity Distribution Agreement, or the Distribution Agreement, with Canaccord Genuity Inc., as sales agent, or Canaccord, pursuant to which we could, at our discretion, offer and sell, from time to time, through Canaccord shares of our common stock having an aggregate offering price of up to $30.0 million. Under the Distribution Agreement, Canaccord could sell shares by any method deemed to be an “at-the-market” offering as defined in Rule 415 under the Securities Act or any other method permitted by law, including in privately negotiated transactions.

We began sales under the Distribution Agreement in August 2016 pursuant to an effective shelf registration statement on Form S-3 previously filed with the SEC. During the three months ended September 30, 2016, we sold 3.3 million shares of our common stock, at an average per share price of $9.04, for aggregate gross proceeds of $30.0 million. We incurred $1,143,000 in related transaction costs, comprising commissions paid to Canaccord of 3.0% of the aggregate gross proceeds from each sale of shares occurring pursuant to the Distribution Agreement, or $900,000, and $243,000 in additional miscellaneous expenses.

Letter of Credit

In September 2012, we provided a $758,000 letter of credit issued by Banc of California to the landlord of our executive office facility in Carlsbad, California. This letter of credit was secured with $758,000 of restricted cash at December 31, 2016. 

If we require additional capital, we cannot be certain that it will be available when needed or that our actual cash requirements will not be greater than anticipated. If we raise additional funds through the issuance of equity or convertible debt securities, 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 raise additional funds through collaborations or 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.

Contractual Obligations
 
As of December 31, 2016, we had the following contractual obligations (in thousands): 
 
Payments due by period
 
Total
 
Less than
1 Year
 
1-3
Years
 
4-5
Years
 
After 5
Years
Lease obligations (1)
$
10,058

 
$
1,644

 
$
5,677

 
$
2,143

 
$
594

Licensing payment obligations
1,750

 
1,494

 
181

 
75

 

Instrument purchase obligations
1,278

 
1,309

 

 

 

Total obligations
$
13,086

 
$
4,447

 
$
5,858

 
$
2,218

 
$
594

 _____________________
(1)
We enter into leases in the ordinary course of business with respect to facilities. Our lease agreements have fixed payment terms based on the passage of time. Certain facility leases require payment of maintenance and real estate taxes. Our future operating lease obligations could change if we terminate certain contracts or if we enter into additional leases.

In January 2012, we entered into a lease amendment with the landlord of our Carlsbad, California executive office facility to rent an additional 22,000 square feet. The lease amendment required an additional security deposit of $22,000 and an increase in our standby letter of credit to $758,000. We took possession of the additional space on January 1, 2013, at which time the rent increased by approximately $35,000 per month, subject to annual increases of between 3% and 4%. The term of the lease was also extended to June 30, 2021.

In August 2012, we entered into a three-year supply agreement with Leica for the purchase of our XT-8 instrument. Amounts reported in the table above reflect minimum purchase commitments under this supply agreement which we can satisfy through instrument purchases or the payment of a designated fee for each instrument we fail to purchase under the prescribed minimum amounts, subject to certain permitted exclusions.

In December 2015, we entered into a manufacturing and supply agreement with Plexus for the purchase of our ePlex instrument. Amounts reported in the table above reflect the current minimum purchase commitments under this supply agreement, which we satisfy through instrument and component part purchases.
 

35


In June 2015, we entered into a lease agreement for additional manufacturing space located in Carlsbad, California. Pursuant to the lease agreement, rent payments total $4,490,000 over the 90-month lease term.

Impact of Inflation
 
The effect of inflation and changing prices on our operations was not significant during the periods presented.
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements. We have provided a $758,000 standby letter of credit to our landlord as security for future rent in connection the lease of our Carlsbad, California corporate headquarters, which is recorded as restricted cash on our consolidated balance sheet.

Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Quantitative and Qualitative Disclosures about Market Risk
 
Our exposure to market risk is limited to our cash and cash equivalents, all of which have maturities of less than three months, and marketable securities, which have maturities of less than one year. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs, and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk. To achieve our goals, we may in the future maintain a portfolio of cash equivalents and investments in a variety of securities that management believes to be of high credit quality. We currently do not hedge interest rate exposure. Because of the short-term maturities of our cash equivalents and short-term investments, we do not believe that an increase in market rates would have a material negative impact on the value of our portfolio.
 
Interest Rate Risk
 
As of December 31, 2016, based on current interest rates and total debt outstanding, a hypothetical 100 basis point increase or decrease in interest rates would have an insignificant pre-tax impact on our results of operations.
 
Foreign Currency Exchange Risks
 
We are a U.S. entity and our functional currency is the U.S. dollar. Substantially all of our revenues were derived from sales in the United States. We have business transactions in foreign currencies, however, we believe we do not have significant exposure to risk from changes in foreign currency exchange rates at this time. We do not currently engage in hedging or similar transactions to reduce our foreign currency risks. We will continue to monitor and evaluate our internal processes relating to foreign currency exchange, including the potential use of hedging strategies.

36



Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of GenMark Diagnostics, Inc.

We have audited the accompanying consolidated balance sheets of GenMark Diagnostics, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GenMark Diagnostics, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), GenMark Diagnostics, Inc.'s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 28, 2017 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

San Diego, California
February 28, 2017




37


GENMARK DIAGNOSTICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
 
As of December 31,
 
2016
 
2015
Current assets
 
 
 
Cash and cash equivalents
$
15,959

 
$
35,385

Marketable securities
25,607

 
10,080

Accounts receivable, net of allowances of $2,740 and $2,727, respectively
9,048

 
6,847

Inventories
6,633

 
3,054

Prepaid expenses and other current assets
1,202

 
591

Total current assets
58,449

 
55,957

Non-current assets
 
 
 
Property and equipment, net
18,268

 
11,396

Intangible assets, net
2,670

 
2,376

Restricted cash
758

 
758

Other long-term assets
179

 
180

Total assets
$
80,324

 
$
70,667

Current liabilities
 
 
 
Accounts payable
$
8,703

 
$
4,376

Accrued compensation
5,650

 
3,861

Loan payable
7,935

 
(373
)
Other current liabilities
4,133

 
2,725

Total current liabilities
26,421

 
10,589

Long-term liabilities
 
 
 
Deferred rent
3,652

 
1,257

Long-term debt
11,880

 
9,890

Other non-current liabilities
220

 
334

Total liabilities
42,173

 
22,070

Commitments and contingencies—See note 7

 

Stockholders’ equity
 
 
 
Preferred stock, $0.0001 par value; 5,000 authorized, none issued

 

Common stock, $0.0001 par value; 100,000 authorized; 46,554 and 42,551 shares issued and outstanding as of December 31, 2016 and December 31, 2015, respectively
4

 
4

Additional paid-in capital
393,322

 
353,233

Accumulated deficit
(355,270
)
 
(304,669
)
Accumulated other comprehensive income (loss)
95

 
29

Total stockholders’ equity
38,151

 
48,597

Total liabilities and stockholders’ equity
$
80,324

 
$
70,667

 
 
See accompanying notes to consolidated financial statements.

38


GENMARK DIAGNOSTICS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, except per share data)
 
 
Years ended December 31,
 
2016
 
2015
 
2014
Revenue
 
 
 
 
 
Product revenue
$
48,914

 
$
39,029

 
$
30,328

License and other revenue
360

 
382

 
266

Total revenue
49,274

 
39,411

 
30,594

Cost of revenue
19,700

 
15,317

 
13,127

Gross profit
29,574

 
24,094

 
17,467

Operating expenses
 
 
 
 
 
Sales and marketing
14,734

 
14,385

 
12,629

General and administrative
14,363

 
13,772

 
12,069

Research and development
49,458

 
37,472

 
31,823

Total operating expenses
78,555

 
65,629

 
56,521

Loss from operations
(48,981
)
 
(41,535
)
 
(39,054
)
Other income (expense)
 
 
 
 
 
Interest income
176

 
125

 
244

Interest expense
(1,536
)
 
(880
)
 
(20
)
Other income (expense)
(160
)
 
133

 
(6
)
Total other income (expense)
(1,520
)
 
(622
)
 
218

Loss before provision for income taxes
(50,501
)
 
(42,157
)
 
(38,836
)
Income tax expense (benefit)
100

 
40

 
(573
)
Net loss
$
(50,601
)
 
$
(42,197
)
 
$
(38,263
)
Net loss per share, basic and diluted
$
(1.15
)
 
$
(1.00
)
 
$
(0.93
)
Weighted average number of shares outstanding basic and diluted
44,100

 
42,157

 
41,346

Other comprehensive loss
 
 
 
 
 
Net loss
$
(50,601
)
 
$
(42,197
)
 
$
(38,263
)
Foreign currency translation adjustments
77

 
36

 

Net unrealized gains (losses) on marketable securities, net of tax
(11
)
 
3

 
(20
)
Comprehensive loss
$
(50,535
)
 
$
(42,158
)
 
$
(38,283
)
 
See accompanying notes to consolidated financial statements.

39


GENMARK DIAGNOSTICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
 
 
Common Stock
 
Additional paid-in
capital
 
Accumulated other
comprehensive loss
 
Accumulated
deficit
 
Total stockholders' equity
 
Shares
 
Par Value
 
 
 
 
Balance—December 31, 2013
41,520

 
$
4

 
$
333,363

 
$
10

 
$
(224,209
)
 
$
109,168

Stock-based compensation expense

 

 
5,796

 

 

 
5,796

Issuance of employee stock purchase plan shares
89

 

 
812

 

 

 
812

Restricted stock awards issued, net of cancellations
149

 

 

 

 

 

Shares issued under stock-based compensation plans
101

 

 
531

 

 

 
531

Net loss

 

 

 

 
(38,263
)
 
(38,263
)
Unrealized loss on marketable securities

 

 

 
(20
)
 

 
(20
)
Balance—December 31, 2014
41,859

 
4

 
340,502

 
(10
)
 
(262,472
)
 
78,024

Issuance of stock in lieu of accrued bonuses
105

 

 
863

 

 

 
863

Stock-based compensation expense

 

 
9,995

 

 

 
9,995

Issuance of employee stock purchase plan shares
122

 

 
884

 

 

 
884

Restricted stock awards issued, net of cancellations
284

 

 

 

 

 

Shares issued under stock-based compensation plans
181

 

 
989

 

 

 
989

Net loss

 

 

 

 
(42,197
)
 
(42,197
)
Foreign currency translation adjustments

 

 

 
36

 

 
36

Unrealized gain on marketable securities

 

 

 
3

 

 
3

Balance—December 31, 2015
42,551

 
4

 
353,233

 
29

 
(304,669
)
 
48,597

Issuance of stock in lieu of accrued bonuses
28

 

 
364

 

 

 
364

Stock-based compensation expense

 

 
9,236

 

 

 
9,236

Issuance of employee stock purchase plan shares
138

 

 
921

 

 

 
921

Restricted stock issued, net of cancellations
421

 

 

 

 

 

Shares issued under stock-based compensation plans
99

 

 
712

 

 

 
712

Issuance of common stock, net of offering expenses
3,317

 

 
28,856

 

 

 
28,856

Net loss

 

 

 

 
(50,601
)
 
(50,601
)
Foreign currency translation adjustments

 

 

 
77

 

 
77

Unrealized loss on marketable securities

 

 

 
(11
)
 

 
(11
)
Balance—December 31, 2016
46,554

 
$
4

 
$
393,322

 
$
95

 
$
(355,270
)
 
$
38,151

 
See accompanying notes to consolidated financial statements.

40


GENMARK DIAGNOSTICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Years ended December 31,
 
2016
 
2015
 
2014
Operating activities:
 
 
 
 
 
Net loss
$
(50,601
)
 
$
(42,197
)
 
$
(38,263
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
Depreciation and amortization
3,916

 
3,405

 
2,656

Amortization of premiums on investments
89

 
180

 
702

Amortization of deferred debt issuance costs
388

 
285

 

Stock-based compensation
9,236

 
9,995

 
5,796

Provision for bad debt
13

 
25

 

Non-cash inventory adjustments
134

 
594

 
450

Gain on sale of investment in preferred stock
(9
)
 
(223
)
 

Other non-cash adjustments
145

 
186

 
185

Changes in operating assets and liabilities:
 
 
 
 
 
Accounts receivable
(2,250
)
 
(1,983
)
 
(2,030
)
Inventories
(3,450
)
 
(1,286
)
 
(229
)
Prepaid expenses and other assets
(613
)
 
(36
)
 
(184
)
Accounts payable
4,105

 
(757
)
 
85

Accrued compensation
2,172

 
(458
)
 
1,797

Other liabilities
1,088

 
355

 
(537
)
Net cash used in operating activities
(35,637
)
 
(31,915
)
 
(29,572
)
Investing activities
 
 
 
 
 
Payments for intellectual property licenses
(1,500
)
 
(550
)
 
(350
)
Purchases of property and equipment
(7,000
)
 
(3,756
)
 
(5,726
)
Purchases of marketable securities
(33,688
)
 
(22,646
)
 
(28,054
)
Proceeds from sales of marketable securities
8,015

 
223

 
7,497

Maturities of marketable securities
10,050

 
46,050

 
56,050

Net cash provided by (used in) investing activities
(24,123
)
 
19,321

 
29,417

Financing activities
 
 
 
 
 
Proceeds from issuance of common stock
30,920

 
884

 
812

Costs incurred in conjunction with public offering
(1,143
)
 

 

Principal repayment of borrowings
(40
)
 
(22
)
 
(56
)
Costs associated with debt issuance
(90
)
 
(718
)
 

Proceeds from borrowings
10,000

 
10,000

 

Proceeds from stock option exercises
712

 
989

 
531

Net cash provided by financing activities
40,359

 
11,133

 
1,287

Effect of exchange rate changes on cash
(25
)
 
(9
)
 

Net increase (decrease) in cash and cash equivalents
(19,426
)
 
(1,470
)
 
1,132

Cash and cash equivalents at beginning of year
35,385

 
36,855

 
35,723

Cash and cash equivalents at end of year
$
15,959

 
$
35,385

 
$
36,855

Non-cash investing and financing activities:
 
 
 
 
 
Transfer of systems from property and equipment into inventory
$
263

 
$
225

 
$
256

Property and equipment costs incurred but not paid included in accounts payable
$
1,159

 
$
146

 
$
124

Intellectual property acquisition included in accrued expenses
$

 
$
800

 
$
550

Supplemental cash flow information:
 
 
 
 
 
Cash paid for interest
$
1,130

 
$
572

 
$
20

Cash received for interest
$
266

 
$
305

 
$
244

Cash paid for income taxes, net
$
65

 
$
10

 
$
24

 See accompanying notes to consolidated financial statements.

41


GENMARK DIAGNOSTICS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. Organization and basis of presentation

Organization

GenMark Diagnostics, Inc., the Company or GenMark, was formed by Osmetech plc, or Osmetech, as a Delaware corporation in February 2010, and had no operations prior to its initial public offering, or the IPO, which was completed in June 2010. Immediately prior to the closing of the IPO, GenMark acquired all of the outstanding ordinary shares of Osmetech in a reorganization, accounted for in a manner similar to a pooling-of-interests, under the applicable laws of the United Kingdom. As a result of the reorganization, all of the issued ordinary shares in Osmetech were cancelled in consideration of (i) the issuance of common stock of GenMark to the former shareholders of Osmetech and (ii) the issuance of new shares in Osmetech to GenMark. Following the reorganization, Osmetech became a subsidiary controlled by GenMark, and the former shareholders of Osmetech received shares of GenMark. Any historical discussion of GenMark relates to Osmetech and its consolidated subsidiaries prior to the reorganization. In September 2012, GenMark placed Osmetech into liquidation to simplify its corporate structure. The liquidation of Osmetech was completed in the fourth quarter of 2013.

Segment Reporting

The Company currently operates as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker, who is the chief executive officer, in deciding how to allocate resources and assessing performance. The Company’s business operates in one operating segment because the Company’s chief operating decision maker evaluates the Company’s financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the consolidated financial statements.

Use of Estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, or U.S. GAAP, requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes thereto. The Company’s significant estimates included in the preparation of the financial statements are related to accounts receivable, inventories, property and equipment, intangible assets, employee related compensation accruals, warranty liabilities, tax valuation accounts and stock-based compensation. Actual results could differ from those estimates.
 
Basis of Presentation
 
The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred net losses from operations since its inception and has an accumulated deficit of $355,270,000 at December 31, 2016. Management expects operating losses to continue through the foreseeable future. The Company's ability to transition to attaining profitable operations is dependent upon achieving a level of revenues adequate to support its cost structure through expanding its product offerings and consequently increasing its product revenues. Cash, cash equivalents, restricted cash, and investments at December 31, 2016 totaled $41,566,000. The Company has prepared cash flow forecasts which indicate, based on the Company’s current cash resources available, that the Company will have sufficient resources to fund its business for at least the next 12 months from the date of this filing.
 
The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and applicable regulations of the Securities and Exchange Commission, or the SEC.
 
Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.



42


2. Summary of Significant Accounting Policies and Significant Accounts
 
Cash and Cash Equivalents and Marketable Securities
 
Cash and cash equivalents consist of cash on deposit with banks, money market instruments and certificates of deposit with original maturities of three months or less at the date of purchase. Marketable securities consist of certificates of deposits that mature in greater than three months.  Marketable securities are accounted for as "available-for-sale" with the carrying amounts reported in the balance sheets stated at cost, which approximates their fair market value, with unrealized gains and losses, if any, reported as a separate component of stockholders' equity and included in comprehensive loss.

Restricted Cash
 
Restricted cash represents amounts designated for uses other than current operations and includes $758,000 at December 31, 2016 held as security for the Company’s letter of credit with Banc of California.
 
Fair Value of Financial Instruments
 
The Company uses a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:
 
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Inputs, other than Level 1, that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The carrying amounts of financial instruments such as accounts receivable, prepaid expenses and other current assets, accounts payable, and accrued liabilities approximate the related fair values due to the short-term maturities of these instruments.
 
Receivables
 
Accounts receivable consist of amounts due to the Company for sales to customers and are recorded net of an allowance for doubtful accounts. The allowance for doubtful accounts is determined based on an assessment of the collectability of specific customer accounts, the aging of accounts receivable, and a reserve for unknown items based upon the Company’s historical experience.

The allowance for doubtful accounts as of December 31, 2016, is as follows (in thousands):
 
Allowance for doubtful accounts
Balance December 31, 2014
$
2,702

Provision for doubtful accounts
25

Balance December 31, 2015
$
2,727

Provision for doubtful accounts
13

Balance December 31, 2016
$
2,740


The Company has included $2,702,000 in the allowance for doubtful accounts as of December 31, 2016 and 2015 for past due amounts from its former customer, Natural Molecular Testing Corporation.

Inventories
 
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value and include direct labor, materials, and manufacturing overhead. The Company periodically reviews inventory for evidence of slow-moving or obsolete parts, and writes inventory down to net realizable value, as needed. This write-down is based on management’s review of inventories on hand, compared to estimated future usage and sales, shelf-life assumptions, and assumptions about the likelihood of obsolescence. If actual market conditions are less favorable than those projected by the Company, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not reversed subsequently to income, even if circumstances later suggest that increased carrying amounts are recoverable.
 

43


Property and Equipment-net
 
Property, equipment and leasehold improvements are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which are:
Machinery and laboratory equipment
3 – 5 years
Instruments
4 – 5 years
Office equipment
3 – 7 years
Leasehold improvements
over the shorter of the remaining life of the lease or the useful economic life of the asset
 
Property and equipment includes diagnostic instruments used for sales demonstrations or placed with customers under several types of arrangements, including performance evaluation programs, or PEPs, and reagent rental agreements. PEPs are placed with customers for evaluation periods of up to three months and the Company retains title to the instruments under these arrangements. Maintenance and repair costs are expensed as incurred.
 
Intangible Assets
 
Intangible assets are comprised of licenses or sublicenses to technology covered by patents owned by third parties, and are amortized on a straight-line basis over the expected useful lives of these assets, which is generally 10 years. Amortization of licenses typically begins upon the Company obtaining access to the licensed technology and is recorded in cost of revenues for licenses supporting commercialized products. The amortization of licenses to technology supporting products in development is recorded in research and development expenses.
 
Impairment of Long-Lived Assets
 
The Company assesses the recoverability of long-lived assets, including intangible assets, by periodically evaluating the carrying value whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If impairment is indicated, the Company writes down the carrying value of the asset to its estimated fair value. This fair value is primarily determined based on estimated discounted cash flows. The Company did not recognize any impairment charges during the years ended December 31, 2016 and 2015.
 
Revenue Recognition
 
The Company recognizes revenue from product sales and contract arrangements, net of discounts and sales related taxes. The Company recognizes revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured.
 
The Company offers customers the choice to either purchase a system outright or to receive a system free of charge in exchange for an annual minimum purchase commitment for diagnostic test cartridges. When a system is sold, the Company generally recognizes revenue upon shipment of the unit, however, if the end user already has the instrument being purchased installed at its location, revenue is recognized when the revenue recognition terms other than delivery have been satisfied. When a system is placed free of charge under a “reagent rental” agreement, the Company retains title to the equipment and it remains capitalized on the balance sheet under property and equipment. Under reagent rental agreements, the Company’s customers pay an additional system rental fee for each test cartridge purchased which varies based on the monthly volume of test cartridges purchased. The system rental fee and diagnostic test cartridges are recognized as contingent rental payments and are included in product revenue in the Company’s consolidated financial statements.
 
The Company has not had significant product returns and is not contractually obligated to accept returns unless such returns are related to warranty provisions. The Company generally does not accept reagent product returns, mainly due to FDA regulations, and does not offer volume rebates or provide price protection.
 
The Company enters into PEP agreements pursuant to which an instrument is installed on the premises of a pre-qualified customer for the purpose of allowing the customer to evaluate the instrument’s functionality over an extended trial period. The customer is generally required to purchase a minimum quantity of reagents and, at the end of the evaluation period, must purchase or return the instrument or sign a reagent rental agreement.

Revenues related to royalties received from licenses are recognized evenly over the contractual period to which the license relates. In those cases where the Company bills shipping and handling costs to customers, the amounts billed are included in product revenue.

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In 2016 and 2015, Laboratory Corporation of America, Inc. represented 27% and 17%, respectively, of the Company's total revenue. In 2014, no single customer represented more than 10% of the Company's total revenue.

Product Warranties
 
The Company generally offers a one-year warranty for its instruments sold to customers and up to a sixty day warranty for reagents and provides for the estimated cost of the product warranty at the time the system sale is recognized. Factors that affect the Company’s warranty reserves include the number of units sold, historical and anticipated rates of warranty repairs and the cost per repair. The Company periodically assesses the adequacy of the warranty reserve and adjusts the amount as necessary.
 
Product warranty reserve activity for the years ended December 31, 2016, 2015 and 2014 is as follows (in thousands):
 
2016
 
2015
 
2014
Beginning balance
$
118