HTG MOLECULAR DIAGNOSTICS, INC - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2017

OR

Commission File Number: 001-37369

HTG Molecular Diagnostics, Inc.

(Exact Name of Registrant as Specified in its Charter)

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of May 5, 2017, the registrant had 9,525,814 shares of common stock, $0.001 par value per share, outstanding.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited).

HTG Molecular Diagnostics, Inc.

Condensed Balance Sheets

See notes to the unaudited condensed financial statements.

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HTG Molecular Diagnostics, Inc.

Condensed Statements of Operations

(Unaudited)

See notes to the unaudited condensed financial statements.

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HTG Molecular Diagnostics, Inc.

Condensed Statements of Comprehensive Loss

(Unaudited)

See notes to the unaudited condensed financial statements.

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HTG Molecular Diagnostics, Inc.

Condensed Statement of Changes in Stockholders’ Deficit

(Unaudited)

See notes to the unaudited condensed financial statements.

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HTG Molecular Diagnostics, Inc.

Condensed Statements of Cash Flows

(Unaudited)

See notes to the unaudited condensed financial statements.

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HTG Molecular Diagnostics, Inc.

Notes to Unaudited Condensed Financial Statements

Note 1. Description of Business

HTG Molecular Diagnostics, Inc. (the “Company”) is a commercial stage company that develops and markets products and services based on proprietary technology that facilitates the routine use of targeted molecular profiling. The Company derives revenue from services provided by its VERI/O laboratory and sales of the Company’s automation systems and integrated next-generation sequencing-based HTG EdgeSeq assays.

The Company operates in one segment and its customers are primarily located in the United States. For the three months ended March 31, 2017 and 2016, approximately 18% and 11%, respectively, of the Company’s revenue was generated from sales to customers located outside of the United States.

Note 2. Basis of Presentation

Basis of Presentation

The accompanying interim unaudited condensed financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and reflect the accounts of the Company as of March 31, 2017 and for the quarters ended March 31, 2017 and 2016. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States of America (“GAAP”) for complete financial statements. The accompanying interim unaudited, condensed financial statements reflect all adjustments consisting of normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the Company’s financial position and the results of its operations and cash flows, as of and for the periods presented. The unaudited condensed balance sheet at December 31, 2016 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by GAAP for annual financial statements. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto for the fiscal year ended December 31, 2016, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 23, 2017.

Going Concern

The Company implemented the criteria of Accounting Standards Update (“ASU”) No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, in the first quarter of 2016. In accordance with this guidance, management has assessed the Company’s ability to continue as a going concern within one year of the filing date of this Quarterly Report on Form 10‑Q with the SEC in May 2017. The accompanying unaudited condensed financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. However, the Company has had recurring operating losses and negative cash flows from operations since its inception and has an accumulated deficit of approximately $121.4 million as of March 31, 2017. As of March 31, 2017, the Company had available cash, cash equivalents and short-term investments (classified as available-for-sale securities) of approximately $5.4 million, and had current liabilities of approximately $10.1 million plus an additional $12.3 million in long-term liabilities primarily attributable to its term loan agreement and to an obligation to NuvoGen. During the second quarter of 2017, the Company raised $9.6 million in net proceeds through May 12, 2017 under a sales agreement entered into with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) in April 2017 (see Note 15). After considering the net proceeds raised under the sales agreement with Cantor Fitzgerald, and without assuming any additional sales that may be made under the sales agreement with Cantor Fitzgerald, management believes that the Company’s existing resources will be sufficient to fund the Company’s planned operations and expenditures through the end of the third quarter of 2017. However, the Company cannot provide assurance that its plans will not change or that changed circumstances will not result in the depletion of its capital resources more rapidly than it currently anticipates. These circumstances raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying unaudited condensed financial statements do not include any adjustments that may result from the outcome of these uncertainties.  

The Company will need to raise additional capital to fund its operations until its revenue reaches a level sufficient to provide for self-sustaining cash flows. There can be no assurance that additional capital will be available on acceptable terms, or at all, or that the Company’s revenue will reach a level sufficient to provide for self-sustaining cash flows. If sufficient additional capital is not available as and when needed, the Company may have to delay, scale back or discontinue one or more product development programs, curtail its commercialization activities, significantly reduce expenses, sell assets (potentially at a discount to their fair value or carrying value), enter into relationships with third parties to develop or commercialize independently, cease operations altogether,

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pursue a sale of the Company at a price that may result in up to a total loss on investment for its stockholders, file for bankruptcy or seek other protection from creditors, or liquidate all assets. In addition, if the Company defaults under its term loan agreement, its lenders could foreclose on its assets, including substantially all of its cash and short-term investments which are held in accounts with its lenders.  

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include revenue recognition, stock-based compensation expense, the resolution of uncertain tax positions, income tax valuation allowances, recovery of long-lived assets, inventory obsolescence and inventory valuation. Actual results could materially differ from those estimates.

Fair Value of Financial Instruments

The carrying value of financial instruments classified as current assets and current liabilities approximate fair value due to their liquidity and short-term nature. Investments that are classified as available-for-sale are recorded at fair value, which was determined using quoted market prices, broker or dealer quotations or alterative pricing sources with reasonable levels of transparency. The Company’s asset-secured growth capital term loan with Oxford Finance, LLC and Silicon Valley Bank (the “Growth Term Loan”) and its obligation to NuvoGen Research, LLC. (“NuvoGen”) are considered financial instruments. However, the Company is unable to reasonably determine the fair value of these obligations.

Concentration Risks

Financial instruments that potentially subject the Company to credit risk consist principally of cash and cash equivalents, available‑for‑sale debt securities and uncollateralized accounts receivable. The Company maintains the majority of its cash balances in the form of cash deposits in bank checking and federally secured government money market accounts in amounts in excess of federally insured limits. Management believes, based upon the quality of the financial institution, that the credit risk with regard to these deposits is not significant.

The Company sells its instruments, consumables, sample processing services, custom panel design services and contract research services primarily to biopharmaceutical companies, academic institutions and molecular labs. The Company routinely assesses the financial strength of its customers and credit losses have been minimal to date.

The Company had product revenue consisting of revenue from the sale of instruments and consumables for the three months ended March 31, 2017 and 2016, as follows:

The Company had service revenue consisting of revenue from custom assay development and sample processing for the three months ended March 31, 2017 and 2016, as follows:

The Company’s top three customers accounted for 21%, 20% and 17% of the Company’s total revenue for the three months ended March 31, 2017, compared with 32%, 22% and 9% for the three months ended March 31, 2016.

The top two customers accounted for approximately 24% and 21% of the Company’s accounts receivable as of March 31, 2017, compared with approximately 28% and 15% as of December 31, 2016.  

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The Company currently relies on a single supplier to supply a subcomponent used in the HTG EdgeSeq processors and a second supplier to provide raw materials used in its HTG EdgeSeq proprietary assays. A loss of either of these suppliers could significantly delay the delivery of products or the completion of services to be performed by our VERI/O laboratory, which in turn would materially affect the Company’s ability to generate revenue.

Recently Adopted Accounting Pronouncements

In July 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. The standard requires inventory within the scope of the ASU to be measured using the lower of cost and net realizable value. The changes apply to all types of inventory, except those measured using LIFO or the retail inventory method, and are intended to more clearly articulate the requirements for the measurement and disclosure of inventory and to simplify the accounting for inventory by eliminating the notions of replacement cost and net realizable value less a normal profit margin. The standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016. The Company adopted this guidance prospectively for the fiscal year beginning January 1, 2017. The Company previously measured its inventory at the lower of cost or market with cost being determined by the first-in, first-out (“FIFO”) method. The adoption of the guidance did not have a material impact on the Company’s condensed financial statements.

In April 2016, the FASB issued ASU No. 2016-09, Share-Based Payment: Simplifying the Accounting for Share-Based Payments. The standard addresses several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016. The Company adopted this guidance effective January 1, 2017. Excess tax benefits recorded upon adoption of this standard are not material to the condensed balance sheets. The elimination of the APIC pool affects the treasury stock method used to calculate weighted average shares outstanding; however, the impact was not material. We elected to change our policy surrounding forfeitures, and beginning January 1, 2017, the Company no longer estimates the number of awards expected to be forfeited but rather accounts for them as they occur. The Company was required to implement this portion of the guidance using a modified retrospective approach. However, the cumulative adjustment was not material to additional paid-in capital and, as such, was not recorded. Other provisions of ASU 2016-09 had no impact on the Company’s condensed financial statements.  

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP.

In March 2016, the FASB issued ASU No. 2016-08, Revenue Recognition: Clarifying the new Revenue Standard’s Principal-Versus-Agent Guidance (“ASU 2016-08”). The standard amends the principal-versus-agent implementation guidance and illustrations in ASU 2014-09. ASU 2016-08 clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. As defined in ASU 2016-08, a specified good or service is “a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer.” Therefore, for contracts involving more than one specified good or service, the Company may be the principal in one or more specified goods or services and the agent for others.

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The amendments in this standard affect the guidance in ASU 2014-09 by clarifying two aspects: identifying performance obligations and the licensing implementation guidance.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients. The amendments in this standard affect the guidance in ASU 2014-09 by clarifying certain specific aspects of ASU 2014-09, including assessment of collectability, treatment of sales taxes and contract modifications, and providing certain technical corrections.

The new revenue standard and the standards that amend it will be effective for public entities for fiscal years and interim periods within those fiscal years beginning after December 15, 2017, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is in the initial stages of evaluating the effect of adoption of ASU 2014-09 on its financial statements and continues to evaluate the available transition methods. The Company has begun assessing the standard as it

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will pertain to its collaborative arrangements with multiple deliverables, which includes performing a detailed review of its existing key contracts and comparing historical accounting policies and practices to the new standard. The Company will continue its evaluation of the standards update through the date of adoption.  

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). Under this standard, which applies to both lessors and lessees, lessees will be required to recognize for all leases (except for short-term leases) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard will be effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The effect of adoption of this standard on our financial statements will depend on the leases existing at January 1, 2018. Based on the Company’s preliminary assessment of its office and equipment leases that are in place as of March 31, 2017, however, and considering the practical expedients, the Company expects that adoption of ASU 2016‑02 will not have a material effect on its statements of operations, will result in a gross-up on its balance sheets of less than $3.0 million relating to office and equipment leases and will have no effect on its statements of cash flows. The Company will continue to assess the new guidance and its potential applicability to the other existing agreements, or to new agreements that it may enter into subsequent to March 31, 2017, through the date of adoption.      

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses, which requires the measurement of expected credit losses for financial instruments carried at amortized cost held at the reporting date based on historical experience, current conditions and reasonable forecasts. The updated guidance also amends the current other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The standard will be effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. The effect of adoption will depend on the financial instruments held by the Company at the time. Based on the instruments currently held, however, the Company does not believe the adoption of this standard will have a significant impact on its financial statements, given the high credit quality of the obligors to its available-for-sale debt securities and its limited history of bad debt expense relating to trade accounts receivable. 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim period. When considering the activity within the Company’s statements of cash flow as of the three months ended March 31, 2017 and 2016, the Company does not believe the adoption of this standard will have a significant impact on its financial statements.

Note 3. Inventory

Inventory, net of allowance, consisted of the following as of the date indicated:

For the three months ended March 31, 2017 and 2016, the Company recorded net increases in the inventory reserve of $3,823 and $18,237, respectively, to adjust for estimated shrinkage and obsolescence. For the three months ended March 31, 2017 and 2016, increases to the inventory reserve of $192,427 and $30,542 have been included in the cost of revenue, respectively.  

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Note 4. Fair Value Instruments

The carrying value of financial instruments classified as current assets and current liabilities approximate fair value due to their liquidity and short-term nature. Investments that are classified as available-for-sale are recorded at fair value, which was determined using quoted market prices, broker dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

Financial assets and liabilities measured at fair value are classified in their entirety in the fair value hierarchy, based on the lowest level input significant to the fair value measurement. The following table classifies the Company’s financial assets and liabilities measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016, respectively, in the fair value hierarchy:

There are no other financial instruments subject to fair value measurement on a recurring basis. Transfers to and from Levels 1, 2 and 3 are recognized at the end of the reporting period. There were no transfers between levels for the three months ended March 31, 2017.  

Level 1 instruments include investments in federally secured government money market funds and U.S. Treasuries. These instruments are valued using quoted market prices for identical unrestricted instruments in active markets. The Company defines active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity. Level 2 instruments include corporate debt securities. Valuations of Level 2 instruments can be verified to quoted prices, recent trading activity for identical or similar instruments, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Fair values of these assets are based on prices provided by independent market participants that are based on observable inputs using market-based valuation techniques. These valuation models and analytical tools use market pricing or similar instruments that are both objective and publicly available, including matrix pricing or reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids and/or offers. The Company did not adjust any of the valuations received from these third parties with respect to any of its Level 1 or 2 securities for the periods ended March 31, 2017 or December 31, 2016.

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Note 5. Available for Sale Securities

The Company’s portfolio of available-for-sale securities consists of U.S. Treasuries and high credit quality corporate debt securities. The following is a summary of the Company’s available-for-sale securities at March 31, 2017 and December 31, 2016:  

The net adjustment to unrealized holding gains on available-for-sale securities, net of tax in other comprehensive income totaled $354 and $39,351 and for the three months ended March 31, 2017 and 2016, respectively.

Contractual maturities of debt investment securities at March 31, 2017 are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

The following table shows the gross unrealized losses and fair values of the Company’s investments that have unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2017:

For debt securities, the Company determines whether it intends to sell or if it is more likely than not that it will be required to sell impaired securities. This determination considers current and forecasted liquidity requirements, regulatory and capital requirements and securities portfolio management. For all impaired debt securities for which there was no intent or expected requirement to sell, the evaluation considers all available evidence to assess whether it is likely the amortized cost value will be recovered. The Company conducts a regular assessment of its debt securities with unrealized losses to determine whether securities have other-than-temporary impairment considering, among other factors, the nature of the securities, credit rating or financial condition of the issuer, the extent and duration of the unrealized loss, expected cash flows of underlying collateral, market conditions and whether the Company intends to sell or it is more likely than not that the Company will be required to sell the debt securities. The Company did not have any other-than-temporary impairment in its available-for-sale securities at March 31, 2017 or December 31, 2016.

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Note 6. Property and Equipment

Property and equipment, net, consists of the following:

Depreciation and leasehold improvement amortization expense was $296,045 and $357,023 for the three months ended March 31, 2017 and 2016, respectively.  

Note 7. Accrued Liabilities

Accrued liabilities consist of the following:

Note 8. Debt Obligations

Growth Term Loan

There have been no significant modifications to the terms and conditions of the Growth Term Loan since the disclosures made in the Company’s Annual Report on Form-10K, filed with the SEC on March 23, 2017. The remaining principal repayments due under the Growth Term Loan as of March 31, 2017 are as follows for each fiscal year:  

Note 9. Other Agreements

NuvoGen Obligation

There have been no significant modifications to the terms and conditions of the Company’s NuvoGen obligation since the disclosures made in the Company’s Annual Report on Form 10-K, filed with the SEC on March 23, 2017. The minimum remaining payments due

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to NuvoGen at March 31, 2017 are as follows for each fiscal year, although actual payments could be significantly more than provided in the table in 2018 and beyond, to the extent that 6% of revenue exceeds $400,000:

Development Agreements

There have been no significant modifications or financial events relating to the development agreements entered into by the Company in prior periods with Illumina, Inc., Invetech PTY Ltd., and Life Technologies Corporation since the disclosures made by the Company in its Annual Report on Form 10-K, filed with the SEC on March 23, 2017.

Collaboration Agreements

There have been no significant modifications or financial events relating to the previously disclosed collaboration agreements entered into by the Company with Bristol-Myers Squibb and with Merck KGaA since disclosures made by the Company in its Annual Report on Form 10‑K, filed with the SEC on March 23, 2017.

Other Agreements with Related Parties

Refer to Note 14 for discussion of agreements with related parties.

Note 10. Net Loss Per Share

Net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock or common stock equivalents outstanding. Accordingly, the numerator and the denominator used in computing both basic and diluted net loss per share for each period are the same. The following table provides a reconciliation of the numerator and denominator used in computing basic and diluted net loss per share for the periods presented:

The following outstanding options and warrants were excluded from the computation of diluted net loss per share for the periods presented because their effect would have been anti-dilutive:

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Note 11. Stockholders’ Deficit

Treasury Stock

In January 2017, the Company’s board of directors approved the retirement of the 1,396 shares of the Company’s common stock previously held in treasury, and returned them to the status of authorized and unissued shares of the Company’s common stock.

Stock-based Compensation

As of March 31, 2017, there were 110,215 shares available for issuance under the Company’s 2014 Equity Incentive Plan (the “Plan”) and options to purchase 1,441,924 shares of common stock were outstanding, including 674,270 options that were fully vested. As of March 31, 2017, there was total unrecognized compensation expense of $1,181,357 related to unvested stock options, which the Company expects to recognize over a weighted-average period of approximately 1.84 years.

A summary of the Plan’s stock option activity is as follows:

In January 2017, the Company’s board of directors approved the granting of 211,500 employee incentive stock options. Black-Scholes assumptions used to calculate the fair value of this stock option grant were as follows:

As of March 31, 2017, there were 256,499 restricted stock units (“RSUs”) outstanding, including 55,000 vested and unissued RSUs and 201,499 unvested RSUs. Unrecognized compensation expense related to the remaining unvested RSUs was $384,164 at March 31, 2017, which the Company expects to recognize over a weighted-average remaining service period of 0.6 years.

A summary of the Plan’s RSU activity is as follows:

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Stock-based compensation expense recorded in the condensed statements of operations for the three months ended March 31, 2017 and 2016 was as follows:

Note 12. Commitments and Contingencies

Legal Matters

The Company’s industry is characterized by frequent claims and litigation, including claims regarding intellectual property and product liability. As a result, the Company may be subject to various legal proceedings from time to time. The results of any current or future litigation cannot be predicted with certainty, and regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors. Any current litigation is considered immaterial and counter claims have been assessed as remote.

Leases

The Company leases office and laboratory space in Tucson, Arizona under two non-cancelable operating leases. There have been no changes to the Company’s office and laboratory space leases since the disclosures made by the Company in its Annual Report on Form 10-K, filed with the SEC on March 23, 2017. The Company’s remaining minimum real estate lease payments before common area maintenance charges for each fiscal year as of March 31, 2017 are as follows:  

As of March 31, 2017, the Company also has capital lease commitments consisting of approximately $104,000 of leases for computer equipment varying in length from 36 to 48 months and an equipment financing arrangement of approximately $21,000 with a vendor that expires in December 2017 that have not been included in the minimum lease payments schedule above.  

Product Warranty

The following is a summary of the Company’s general product warranty liability:  

Warranty accrual is included in accrued liabilities in the condensed balance sheets as of March 31, 2017 and December 31, 2016. Expense relating to the recording of this accrual is recorded in cost of revenue within the condensed statements of operations.

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Note 13. Income Taxes

The Company provides for income taxes based upon management’s estimate of taxable income or loss for each respective period. The Company recognizes an asset or liability for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. These temporary differences would result in deductible or taxable amounts in future years, when the reported amounts of the assets are recovered or liabilities are settled, respectively.

In each period since inception, the Company has recorded a valuation allowance for the full amount of its net deferred tax assets, as it is not more likely than not that these will be realized. As a result, the Company has not recorded any federal or state income tax benefit in the statements of operations; however, state income tax expense has been recorded for state minimum taxes.

The Company periodically reviews its filing positions for all open tax years in all U.S. federal, state and international jurisdictions where the Company is or might be required to file tax returns or other required reports.  The Company applies a two-step approach to recognizing and measuring uncertain tax positions. The Company evaluates 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 in a court of last resort. The term “more likely than not” means a likelihood of more than 50 percent. Otherwise, the Company may not recognize any of the potential tax benefit associated with the position. The Company recognizes a benefit for a tax position that meets the more likely than not criterion at the largest amount of tax benefit that is greater than 50 percent likely of being realized upon its effective resolution. Unrecognized tax benefits involve management’s judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions could result in adjustments to recorded amounts and may affect the Company’s results of operations, financial position and cash flows. The Company has not identified any uncertain tax positions at March 31, 2017 or December 31, 2016.

The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties at March 31, 2017 and December 31, 2016, respectively, and has not recognized interest or penalties of significance during the three months ended March 31, 2017 and 2016, respectively, since there are no material unrecognized tax benefits. The Company has not made or had payments due for income taxes for the periods ended March 31, 2017 or December 31, 2016. Management believes no material change to the amount of unrecognized tax benefits will occur within in the next 12 months.

The Company has established a valuation allowance against the entire deferred tax asset. A preliminary analysis of past and subsequent equity offerings by the Company, and other transactions that have an impact on the Company’s ownership structure, concluded that the Company may have experienced one or more ownership changes under Sections 382 and 383 of the Internal Revenue Code or IRC.  Provisions of the IRC place special limitations on the usage of net operating losses and credits following an ownership change. Such limitations may limit or eliminate the potential future tax benefit to be realized by the Company from its accumulated net operating losses and research and development credits.

Note 14. Related-Party Transactions

QIAGEN Agreement

There have been no significant modifications or financial events relating to the Company’s agreements with QIAGEN Manchester Limited or with QIAGEN North American Holdings, Inc. (“QNAH”) since disclosures made by the Company in its Annual Report on Form 10-K, filed with the SEC on March 23, 2017.

As disclosed previously, QNAH agreed to purchase up to an additional $2.0 million of the Company’s common stock (subject to any applicable limitations under the rules of the NASDAQ Stock Market) upon the sale by the Company of at least $12.0 million of common or preferred stock in a financing transaction that occurs prior to May 16, 2017, or such other mutually agreeable date (a “Qualified Financing”). The price per share payable by QNAH in a second tranche closing will be equal to the price per share at which shares are sold in a Qualified Financing.

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Note 15. Subsequent Events

Cantor Fitzgerald & Co. Market Offering

On April 13, 2017, the Company entered into a Controlled Equity Offering Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co., as sales agent (“Cantor Fitzgerald”), pursuant to which the Company may offer and sell, from time to time, through Cantor Fitzgerald, shares of the Company’s common stock, par value $0.001 per share, having an aggregate offering price of up to $20.0 million (the “ATM Offering”). The shares are being offered and sold pursuant to the Company’s shelf registration statement on Form S-3 (File No. 333-216977), which was filed with the SEC in March 2017 and became effective in April 2017. Under the Sales Agreement, Cantor Fitzgerald may sell shares by any method deemed to be an “at the market offering” as defined in Rule 415 under the Securities Act of 1933, as amended, or any other method permitted by law.

As of May 12, 2017, the Company has sold 1,775,367 shares of common stock under the ATM Offering at then-market prices for total gross proceeds of approximately $10.0 million. After sales commissions and other expenses payable by the Company in connection with the ATM Offering, the Company’s aggregate net proceeds through May 12, 2017 were approximately $9.6 million.

Legal fees incurred in connection with the S-3 offering of approximately $77,700 have been capitalized as deferred offering costs in the condensed balance sheets as of March 31, 2017.

Nasdaq Market Transfer

The Company’s common stock is currently listed on The NASDAQ Capital Market under the symbol “HTGM.” Effective April 17, 2017, the listing of the Company’s common stock was transferred to The NASDAQ Capital Market from The NASDAQ Global Market following the Company’s appeal to a NASDAQ Hearings Panel (“Panel”) of the delisting notice received from NASDAQ on February 14, 2017. On April 12, 2017, the Panel found the Company in compliance with the applicable market value of listed securities (MVLS) requirement for listing on The NASDAQ Capital Market. Notwithstanding this result, there can be no assurance that the Company will be able to maintain compliance with the continued listing requirements, including the MVLS requirement, of The NASDAQ Capital Market.

Compensatory Arrangements of Certain Officers

On April 13, 2017, the Company’s Board of Directors approved a performance-based retention and incentive bonus award (“Bonus Award”) aggregating approximately $302,000 for the Company’s named executive officers. The Bonus Awards are, in part, in consideration of the Company’s performance during 2016, but are expressly conditioned upon the completion by the Company of a financing transaction, or series of related financing transactions, in which the Company raises aggregate gross proceeds in excess of $12.0million and with respect to each named executive officer, his continued employment through the completion of such financing transaction(s) (the “Financing Goal”). No Bonus Awards will be earned or paid if the Financing Goal does not occur. Because payment of the Bonus Awards is expressly conditioned on the Financing Goal, compensation expense related to the Bonus Awards, in excess of the amount accrued as of December 31, 2016 (which accrual was based in part on the determination by the Company’s Board of Directors that the 2016 corporate goals had been achieved at an aggregate level of 47.5%), will be recognized upon consummation of the Financing Goal.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with our financial statements and notes thereto for the year ended December 31, 2016, and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 23, 2017. This discussion and analysis contains certain 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. These statements relate to future events or to our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Forward looking statements include, but are not limited to, statements about:

In some cases, you can identify these statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, and similar expressions. These forward-looking statements reflect our management’s beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this filing and are subject to risks and uncertainties. We discuss many of these risks in greater detail in Part II, Item 1A - “Risk Factors” and elsewhere in this filing. You should carefully read the “Risk Factors” section of this filing to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements. These statements, like all statements in this report, speak only as of their date, and except as required by law, we assume no obligation 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. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we make. Given these uncertainties, you should not place undue reliance on these forward-looking statements.

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Overview

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

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

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

Our current sources of revenue include services provided by our VERI/O laboratory (discussed below) and sales of our automation systems and integrated NGS-based HTG EdgeSeq assays. Our current assay product offerings include the following:

Our assays are currently sold for research use only, except in Europe where our diffuse large B-cell lymphoma, or DLBCL, assay and our HTG EdgeSeq ALKPlus Assay EU are CE-marked and available for diagnostic use. We continue work on the pre-market approval, or PMA, submission for our HTG EdgeSeq ALKPlus Assay in the United States. We also have a focused development pipeline of new profiling products, which includes planned panels for translational research, drug development, and molecular diagnostics with initial focus in immuno-oncology and next generation pathology. We also expect to complete feasibility testing on several new technological developments in 2017, including our direct-target sequencing “version 2” chemistry, or V2 chemistry.

Our HTG EdgeSeq assays are automated on either our HTG Edge or HTG EdgeSeq platform, which may also be referred to as an “instrument” or “processor” and which, together with the assay, is a fully integrated system. Our HTG Edge platform can run both our original, plate-based assays and our NGS-based HTG EdgeSeq assays. We continue to support a small number of customers interested in utilizing our plate-based assays (such as our HTG Edge DMPK Core CYP Assay or otherwise on a custom manufacturing basis); however, in 2016, based on market trends and customer feedback, we shifted our product focus to our NGS‑based HTG EdgeSeq system.

Customers can also obtain the advantages of our proprietary technology by engaging our VERI/O laboratory for pre-clinical and clinical research-related services, including drug development and translational research. Our VERI/O lab processes samples for molecular profiling data or if aligned with our clinical diagnostic product strategy, designs custom research or investigational profiling assays. Beginning in April 2017, we also offer our V2 chemistry in our VERI/O laboratory for detection of certain DNA mutations.

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

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We have incurred significant losses since our inception, and we have never been profitable. We incurred net losses of $5.8 million and $7.0 million for the three months ended March 31, 2017 and 2016, respectively, and we had an accumulated deficit of approximately $121.4 million as of March 31, 2017. As of March 31, 2017, we had available cash and cash equivalents totaling approximately $2.8 million and investments in short-term corporate and government debt securities totaling $2.6 million, and had current liabilities of approximately $10.1 million, plus an additional $12.3 million in long-term liabilities primarily attributable to our Growth Term Loan and our obligation to NuvoGen.

Recent Developments

In May 2017, we announced that our new HTG EdgeSeq PATH Assay is expected to be available for research uses by the end of the second quarter of 2017. The HTG EdgeSeq PATH Assay (previously referred to as Project Mercury) has been designed for retrospective gene expression profiling to complement traditional immunohistochemistry, or IHC, testing by allowing investigators to assess mRNA expression of large numbers of biomarkers when formalin-fixed, paraffin-embedded sample availability is limited. The assay is designed to detect up to 470 mRNA targets, typically assessed by IHC.

In April 2017, we entered into a Controlled Equity Offering Sales Agreement with Cantor Fitzgerald & Co., as sales agent, pursuant to which we may offer and sell, from time to time, through Cantor Fitzgerald, shares of our common stock having an aggregate offering price of up to $20.0 million, or the ATM Offering. The shares are being offered and sold pursuant to our shelf registration statement on Form S-3 (File No. 333-216977), which was filed with the SEC in March 2017 and became effective in April 2017. As of May 12, 2017, the Company has sold 1,775,367 shares of common stock in the ATM Offering at then-market prices for total gross proceeds of approximately $10.0 million. After sales commissions and other expenses payable by the Company in connection with the ATM Offering, the Company’s aggregate net proceeds through May 12, 2017 were approximately $9.6 million.  

In April 2017, we received notice from The NASDAQ Stock Market LLC indicating that the Nasdaq Hearings Panel would transfer the listing of our common stock from The Nasdaq Global Market to The Nasdaq Capital Market based upon our compliance with all requirements for continued listing on the latter market. The intra-market transfer took effect upon the open of trading on April 17, 2017.

In April 2017, we entered into a master services agreement with Daiichi Sankyo Company, Limited for work to be performed in our VERI/O laboratory. The initial project includes the development of a custom assay for the detection of nearly 3,000 mRNA targets using our HTG EdgeSeq technology and the processing of several hundred samples using the HTG EdgeSeq ALKPlus Assay EU in a research use only mode for exploratory research on new, potential therapeutic biomarkers.

In April 2017, we entered into a research agreement with Centre Léon Bérard, which provides the framework for molecular profiling studies aimed to advance precision medicine. The initial project utilizes our HTG EdgeSeq Oncology Biomarker Panel to retrospectively characterize immunologic profiles from advanced malignant tumor samples collected in the ProfiLER study (ClinicalTrials.gov identifier NCT01774409).

In April 2017, we also entered into a research collaboration agreement with Instituto Valenciano de Oncología (IVO). The initial project, utilizing the HTG EdgeSeq Oncology Biomarker Panel, will focus on the development and validation of a breast cancer recurrence risk score, based on genes that are differentially expressed between patients with low and high risk of recurrence.

In March 2017, we announced that our HTG EdgeSeq technology was successfully adapted for use with the QIAGEN GeneReader NGS System based on the results of an initial technical feasibility test, which advances our precision diagnostics collaboration with QIAGEN Manchester Limited, announced in November 2016.

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Results of Operations

Comparison of the Three Months Ended March 31, 2017 and 2016

Revenue

We generate revenue from the sale of our HTG Edge and HTG EdgeSeq platforms and our consumables, which consist primarily of our proprietary molecular profiling panels and other assay components. Together, all such consumables may be referred to as assays, assay kits or kits. We also generate revenue through the sale of services performed by our VERI/O laboratory related to our proprietary technology, such as sample processing, custom research-use-only assay development and pursuant to collaboration agreements with our biopharmaceutical customers, development of IVD assays. Total revenue for the three months ended March 31, 2017, increased by 58% to $1.4 million compared with $0.9 million for the three months ended March 31, 2016. The overall revenue increase for the three months ended March 31, 2017 compared to the same period in the prior year was primarily the result of increased demand for sample processing by our biopharmaceutical company customers, a trend that we expect to continue in future reporting periods.

Product revenue

          Product revenue includes revenue from the sale of our HTG EdgeSeq instruments and related consumables, and was $0.5 million for the three months ended March 31, 2017, compared with $0.6 million for the three months ended March 31, 2016, and was comprised of the following:

          Revenue generated from instrument sales, rental and extended warranty services for the three months ended March 31, 2017, was $23,000 compared with $80,000 for the three months ended March 31, 2016. Consumables revenue was $0.5 million for both the three months ended March 31, 2017 and 2016. The decrease in product revenue from 2016 to 2017 is primarily attributable to our focus on biopharmaceutical customers whose preference has been to access our technology via services in our VERI/O laboratory. We expect our revenue mix to continue to contain a high proportion of biopharmaceutical service revenue in the near term until potential companion diagnostic products result from our collaborations with biopharmaceutical customers or we independently develop additional menu items for the commercial clinical diagnostic markets, especially in the United States.

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Service revenue

Service revenue, consisting primarily of sample processing for biopharmaceutical company customers, increased to $0.8 million for the three months ended March 31, 2017, compared with $0.3 million for the three months ended March 31, 2016. Service revenue reflects, in part, new or increasing activity with our biopharmaceutical company customers.

Our increasing service revenue for the three months ended March 31, 2017, compared to the same period in 2016 reflects growth both in the number of biopharmaceutical company customers purchasing our VERI/O laboratory service offerings and in the amount of work performed for our service customers. We continue to enter into new agreements or expand the scope of our existing biopharmaceutical collaborations and service agreements with biopharmaceutical company customers, who have chosen our proprietary technologies for use in their translational research and drug development programs, and who prefer to access our technology via our VERI/O laboratory services. Because of existing agreements with biopharmaceutical company customers and continued efforts to expand our services to new biopharmaceutical company customers in the future, we expect our service revenue to continue to increase in both absolute dollars and as a percentage of total revenue in 2017.

Cost of revenue

Cost of revenue includes the aggregate costs incurred in manufacturing, delivering, installing and servicing instruments and consumables, as well as costs incurred for services performed for customers in our VERI/O laboratory. Cost of revenue increased by $452,000, or 54% in the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Our increased gross margin for the three months ended March 31, 2017, reflects our expectation of further improvement in our overall gross margin as our revenues increase, allowing further absorption of our largely fixed manufacturing costs. These costs include increased facility rental costs incurred in 2016 from improvement and expansion of our dedicated manufacturing and operations space and additional laboratory equipment purchased to meet the increasing service activities in our VERI/O laboratory. Custom assay development projects will occasionally cause us to incur costs ahead of revenue. We incurred approximately $65,000 of custom assay development project costs for which no corresponding revenue was recognized during the three months ended March 31, 2017, decreasing our gross margin by the same amount

Selling, general and administrative expenses

Selling, general and administrative expenses were $4.2 million for the three months ended March 31, 2017 compared with $4.7 million for the three months ended March 31, 2016. The decrease was driven primarily by a reduction in headcount and recruiting costs from the first quarter 2016 to the first quarter of 2017. These reductions were a direct result of the reorganization of our commercial sales team in 2016 and a corresponding reduction of ongoing investments into our academic research market. This was partially offset by concentrating our resources on the expansion of biopharmaceutical collaborations and increasing service revenues.

Research and development expenses

Research and development expenses were $1.3 million for the three months ended March 31, 2017, compared with $2.0 million for the three months ended March 31, 2016. Research and development expenses decreased when compared with expenditures in the first quarter of 2016, primarily due to the suspension of Project JANUS in the third quarter 2016. The curtailment of Project JANUS activity allowed us to focus on other nearer-term product development projects.

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Cash Flows for the Three Months Ended March 31, 2017 and 2016

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