HTG MOLECULAR DIAGNOSTICS, INC - Annual Report: 2019 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2019

OR

FOR THE TRANSITION PERIOD FROM                      TO

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

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

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

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

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

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

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 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 definition 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  ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The Nasdaq Capital Market on June 28, 2019, was $46,618,227.

The number of shares of Registrant’s Common Stock outstanding as of March 13, 2020 was 58,403,971.

Table of Contents

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PART I

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

Forward-Looking Statements

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

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

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Item 1. Business.

Overview

We are a commercial stage RNA platform-based life sciences company focused on advancing the promise of precision medicine. Our product and service solutions are based on our proprietary next-generation HTG EdgeSeq technology that enables full RNA profiling using a small amount of biological sample, in liquid or solid forms. Our menu of HTG EdgeSeq assays is automated on our HTG EdgeSeq platform, which applies genomic sequencing tools that generate gene expression data in a timely manner utilizing a simplified workflow for customers. We seek to leverage key business drivers in molecular profiling for biomarker analysis and diagnostics, including the acceleration of precision medicine, the migration of molecular testing to NGS-based applications, the movement to smaller and less invasive biopsies, the need for greater diagnostic sensitivity, the need to conform to challenging healthcare economics and the need for automation and an easily deployable workflow, including simplified bioinformatics. For example, these capabilities enable customers to extend the use of limited biological samples for retrospective analysis, gaining further understanding of the molecular drivers of disease with the goal of developing biomarker-driven targeted therapies. We also believe our HTG EdgeSeq technology can be used as a platform technology in clinical applications that will simplify, consolidate and reduce the cost of NGS-based diagnostic workflows and in commercialized companion diagnostic (“CDx”) tests.

Our products include instruments, consumables, including assay kits, and software that, as an integrated system, automate sample processing and can quickly, robustly and simultaneously profile tens, hundreds or thousands of molecular targets from samples a fraction of the size required by many prevailing technologies. Our objective is to establish our solutions as the standard in molecular profiling, companion diagnostic development and molecular diagnostics, and to make their benefits accessible to all molecular labs from research to the clinic. We believe that our target customers desire high quality molecular profiling information in a multiplexed panel format from increasingly smaller and less invasive samples, with the ability to test and the option to analyze such information locally to minimize turnaround time and cost.

In 2014, we launched our HTG EdgeSeq technology solution, which generates a molecular profiling library for gene expression profiling using NGS. Our HTG EdgeSeq assays are automated on our HTG EdgeSeq platform. Our innovative platform and menu of molecular profiling panels are being utilized in two complimentary ways in advancing precision health. Biopharmaceutical companies and other translational research centers utilize our technology to discover and validate biomarkers and develop molecular subtypes which can identify patient populations most likely to respond to certain therapies. In addition to purchasing our technology for use in customer facilities, customers can also obtain the advantages of our proprietary technology through our service offerings. Pre-clinical services, including custom assay development and sample processing services provided by our Tucson-based VERI/O laboratory, allow customers the ability to more efficiently identify and validate biomarker signatures across their drug portfolios or patient cohorts. Our ISO 13485-2016 certified quality system and diagnostic development teams, in partnership with biopharmaceutical company customers, develop, manufacture and commercialize companion diagnostics. Although our initial focus has been oncology, we offer customers a full solution from biomarker discovery to deployment of CDx tests across numerous disease states. Utilizing NGS as our method of detection provides our customers with the benefits of our highly multiplexed and extraction-free chemistry and the sensitivity and dynamic range of the sequencers, providing a powerful value proposition and complete workflow.

Our HTG EdgeSeq platform is currently focused on RNA-based applications, which we believe is a large and growing market with significant, unmet medical needs where we have demonstrated our competitive advantages. We believe that our platform technology can enable gene expression profiling growth to accelerate as we make NGS-based gene expression analysis easier and more sample sparing.

We have two primary sources of revenue: product and product-related services revenue from the sale of research use only (“RUO”) and CE/IVD marked profiling products, sample processing services and custom assay development services to biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for companion diagnostic development programs for biopharmaceutical companies.

Profiling product and product-related services revenue includes customer purchases of our HTG EdgeSeq instrument and related assay kits, development of custom RUO assay kits for customers and the use of our HTG EdgeSeq instrument and RUO assay kits to process samples on the customer’s behalf in our VERI/O laboratory. In addition, as of December 31, 2019, we sell two internally developed proprietary CE/IVD marked assays, including our HTG EdgeSeq DLBCL Cell of Origin Assay EU and HTG EdgeSeq ALKPlus Assay EU. Several additional diagnostic tests are in early stage development in collaboration with our European customers. Our team of field-based and support services employees throughout Europe facilitate our ability to generate product revenue in Europe and to improve our responsiveness to customer needs in that region. While we have determined that we will no longer maintain an applications laboratory in Sausheim, France, we will continue to perform sample processing and collaborative development services for our global customer base in our VERI/O laboratory in the United States.

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Collaborative development services revenue relates to services performed using our HTG EdgeSeq proprietary technology to develop, seek regulatory approval for, and commercialize companion diagnostic assays for biopharmaceutical drug candidates and corresponding therapeutics. Collaborative development services revenue generated to date has been generated primarily pursuant to the Master Assay Development, Commercialization and Manufacturing Agreement between us and QIAGEN Manchester Limited (“QML”) dated November 2016 (the “Governing Agreement”). These primary revenue sources are currently consumed by our customers primarily through a services-oriented model. However, we anticipate that this will be a catalyst toward an emerging product-based strategy as an increase in our menu of diagnostic panels is expected to result in increased demand for our instrument and HTG EdgeSeq consumable products in individual laboratories and customer locations. In November 2019, we terminated the Governing Agreement, effective immediately, as a result of QML’s material breach of the Governing Agreement, including QML’s failure to develop an in vitro diagnostic (“IVD”) version of its GeneReader sequencing platform for development of PDP Assays. Our termination of the Governing Agreement did not terminate active statements of work under the Governing Agreement. On a going-forward basis, we expect to enter into additional collaborative development services arrangements directly with biopharmaceutical company customers, which we believe will improve our economics from these arrangements.

In the first quarter of 2019, we announced the initiation of a program for the clinical development of a comprehensive breast cancer molecular diagnostic assay. This program is headquartered in a new development facility in the San Carlos, California. This technical center became operational in July 2019, is now fully functional, and was the result of an objective to access additional collaboration partners and talent that we believe can best support the continued development and expansion of the capabilities of our technology.

Our Strategy

Our objective is to establish our solutions as the standard in gene expression for molecular profiling, and to make their benefits accessible to all molecular labs from research to the clinic. We believe HTG EdgeSeq technology is a platform that we can leverage into three primary revenue verticals: RUO profiling, molecular diagnostics and companion diagnostic collaborations. The key components of our strategy are:

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Our Market Opportunities

Cancer Molecular Profiling and Genomics in Life Science Research

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

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

The supplier market for RNASeq is estimated to be approximately $1.0 billion and growing annually at 10-20%. The gene expression component of that market is estimated to be approximately $820.0 million and growing at the same rate. With these metrics in mind, we expect our target market, NGS-based gene expression profiling, to be between $1.3 billion and $2.0 billion by 2024.

Therapy Driven Diagnostics - Companion Diagnostics

The World Health Organization estimates that cancer will lead to the death of 11.5 million people by 2030. As a result, biopharmaceutical companies are aggressively deploying biomarker driven strategies to improve the response rates to existing and new drugs in development. These companies are looking for technology solutions that can more effectively identify the biological root causes of disease and aid the discovery on biomarkers to better develop and target drugs to the right patients. The companion diagnostic market is currently estimated at $2.6 billion and growing approximately 20% annually. We believe that the acceleration of investment into immunotherapy drugs will also be a catalyst for future companion diagnostics for combination therapies where RNA gene expression classification is expected to be important.

When a molecular biomarker panel is used for selection of patients in a Phase 2 or Phase 3 clinical trial to demonstrate safety and efficacy of a new drug, the drug and biomarker test are often submitted to the applicable regulatory agency for approval together. In the United States, upon U.S. Food and Drug Administration (“FDA”) approval or clearance of the CDx test, the patient must be tested with the CDx test prior to being treated with the drug. Companion diagnostic tests have a clear clinical utility which generally supports favorable reimbursement decisions. We believe there are approximately 3,100 oncology clinical trials, approximately 24% of which are interrogating RNA. This percentage has more than doubled since 2014, and we believe this percentage will approach 50% by 2025.

Molecular Diagnostics – NGS-based Workflows

Complexities and Challenges of Molecular Diagnostics Today

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

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Our Solution

At the core of our solution is our proprietary chemistry known as quantitative nuclease protection (“qNPA”). Our qNPA-based chemistries provide a sensitive and efficient method for analyzing RNA as it eliminates the need for nucleic acid extraction, reverse transcription, complicated bioinformatics steps and other complex processes. We designed and developed our automation platforms and software analysis tools to optimize the capabilities of our chemistries, provide fast turnaround time and enable ease of use to molecular labs. Our chemistries and automation platforms are highly adaptable, so when molecular profiling needs change or emerge, we expect to be able to efficiently add new applications to address these needs.

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

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

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Our Competitive Advantages

We believe that our HTG EdgeSeq technology provides us with a number of competitive advantages that set us apart from others in our industry and that will continue to drive new customers toward our solutions. Such advantages include:

Current Commercial Panels Offered on the HTG EdgeSeq Platform

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

Our currently marketed panels are:

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Our Technology

HTG EdgeSeq Chemistry

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

Key Advantages of our HTG EdgeSeq Chemistry

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HTG Instrument Platform

Our assays and instruments were developed internally and are manufactured in Tucson, AZ under ISO 13485:2016 guidelines using our proprietary HTG EdgeSeq chemistry to simplify multiplexed nucleic acid testing in research and clinical laboratories. The entire workflow from sample preparation to a molecular profiling report can be accomplished in as few as 36 hours for 96 samples. With the speed, flexibility, sensitivity, and accuracy of our HTG EdgeSeq platform, combined with the system’s ability to work effectively with small sample volumes, researchers can profile tens, hundreds or thousands of different genes per sample.

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

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

In addition to direct sales of our systems, we utilize several alternative arrangements to sell our systems. Our platform can be purchased directly by our customers, who also then purchase HTG EdgeSeq assays and other consumables from us on an as-needed basis. In some instances, we provide our instruments free of charge on a limited basis to facilitate customer evaluation. We also may choose to install instruments for our customers at no cost, in exchange for an agreement to purchase assays and other consumables from us at a stated price over the term of the agreement or allow customers to rent our instrument for a monthly fee. As of December 31, 2019, we had an installed base of 61 instruments (consisting of 44 systems sold, four covered under reagent rental agreements, six evaluation units and seven systems with key opinion leaders) and an additional three instruments installed at third-party sites in support of companion diagnostic collaboration projects.

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Opportunities for Comprehensive Molecular Profiling in Diagnostics

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

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

We completed the CE marking of the HTG EdgeSeq ALKPlus Assay EU in Europe in March 2017 as a companion diagnostic for ALK positive therapies in NSCLC lung cancer cases. Information on the ROS1, RET, NTRK1 and HER2 gene rearrangements included in the ALKPlus Assay panel is provided with RUO status. After obtaining the appropriate exemption(s), we believe the ROS1, RET, NTRK1 and HER2 gene rearrangements detected with the ALKPlus Assay could also be used for investigational use only for certain late stage drug development trials, and, as appropriate, receive FDA approval in the future. Our Premarket Approval (“PMA”) application for the HTG EdgeSeq AlkPlus Assay in the U.S. market, which we initiated in 2016, is currently on hold as we evaluate additional medical content for this assay. We also CE/IVD marked our HTG EdgeSeq DLBCL COO EU test in October 2015, which is utilized to differentiate the two main subtypes of DLBCL, ABC and GCB.

We have also initiated early development on a comprehensive whole transcriptome assay intended to allow for breast cancer prognosis and prediction. Over the past decade, significant molecular information and understanding of breast cancer biology has emerged, which we believe has created a substantial opportunity to develop a broader and more comprehensive set of markers and signatures to support clinical decision making using a single panel. We estimate that this type of panel could serve a target market of nearly 1,000,000 patients in Europe and North America, alone; an available market of $1.5 billion assuming current reimbursement rates and a potential for up to 50% market capture for us.

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

Research and Development

We have committed, and expect to commit, significant resources to developing new technologies and products, improving product performance and reliability and reducing costs. We have assembled an experienced research and development team with the scientific, engineering, software and process talent that we believe is required to successfully grow our business. As of December 31, 2019, our research and development team consisted of 35 employees across the disciplines of research and development scientist, platform development and bioinformatics. As a result of fewer collaborative development programs in 2019 and into early 2020, our research and development team was reduced to 28 employees in January 2020.

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

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Sales and Marketing

We distribute our instruments and consumables via direct sales in the United States and Europe and through distributors in parts of Europe and other countries. As of December 31, 2019, our U.S. sales and marketing organization consisted of 18 employees including seven in direct sales or sales management, seven in sales support and four in marketing. In addition to our U.S. sales team, as of December 31, 2019, we had 11 direct sales and support employees in Europe and distribution agreements in several additional countries. This sales model provides us with direct sales coverage in the United Kingdom, France, Germany, Switzerland, Belgium and the Nordic countries, with distributors in Spain, Portugal, Italy and Israel.

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

Manufacturing and Suppliers

We primarily manufacture our products within our facility in Tucson, AZ. External resources are leveraged for their specific expertise in either producing components for our HTG EdgeSeq instrument and raw materials for our consumables in accordance with our designs or based on their catalog products which are utilized as is within our designs. We manufacture HTG EdgeSeq instruments and reagent kits at our Tucson, Arizona facility, which has been certified to ISO 13485:2016 standards. We believe that our existing manufacturing capacity is sufficient to meet our needs for at least the next several years.

Instruments

We assemble our HTG EdgeSeq instruments at our Tucson, Arizona facility. Instrument component vendors are qualified under our quality system and reviewed regularly to ensure that manufacturing standards are met and maintained. We award contracts for estimated annual quantities of components and, considering the replenishment lead times of our vendors, take delivery of batches covering approximately one month of demand at a time.

Consumables

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

Competition

We have categorized known competition into:

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

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

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

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

Intellectual Property

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

Patents and Patent Applications

As of December 31, 2019, our patent portfolio included 13 patent families that, collectively, consisted of seven issued U.S. patents, 49 granted foreign patents (variously in Australia, Canada, China, Japan, France, Germany, Italy, Spain, and United Kingdom), and 19 patent applications pending in the United States and foreign jurisdictions (including one allowed in Canada). This portfolio is directed to our nuclease-protection-based technologies, other nucleic-acid detection methods, and to methods for DLBCL and distinguishing indeterminate nevi from melanoma. Our patent portfolio will help us maintain an exclusive position in key areas of our business, including targeted nuclease-protection based sequencing, and DLBCL cell-of-origin applications of our technology. In addition, this portfolio may provide out‑licensing opportunities, such as, for methods of detecting melanoma or detection of single-nucleotide changes. There were 10 granted patents, including one U.S. patent, directed to our novel HTG EdgeSeq methods in the portfolio as of December 31, 2019. The HTG EdgeSeq method patents will expire in April 2032. Our portfolio also included 19 applications as of December 31, 2019, including six for our direct-target sequencing (V2) HTG EdgeSeq methods, six for our DLBCL subtyping methods, and a provisional application directed to detecting DNA and RNA in the same sample.

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Trade Secrets

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

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

Agreements with Third Parties

Asset Purchase Agreement with NuvoGen Research, LLC

We entered into an asset purchase agreement dated January 9, 2001, as amended in November 2003, September 2004, November 2012 and February 2014, with NuvoGen Research, LLC (“NuvoGen”) to acquire certain intellectual property from NuvoGen. The acquired technology generally relates to our former array-based nuclease protection panels. Pursuant to the terms of the agreement, in exchange for the acquired technology, we initially paid NuvoGen 5,587 shares of our common stock, fixed payments of $740,000 over the first two years of the agreement and, thereafter, agreed to pay NuvoGen the greater of $400,000 per year or 6% of our annual revenue, until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15,000,000. Beginning in 2018, on an annual basis we became obligated to pay the greater of $400,000 or 6% of our annual revenue, until the total aggregate cash compensation paid to NuvoGen under the agreement totals $15,000,000. As of January 1, 2019, and continuing until the remaining obligation has been paid in full, interest on the remaining unpaid obligation has been accrued and compounds annually at a rate of 2.5% per year. Accrued interest on this unpaid obligation is payable on the date that the remaining obligation is paid in full.

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

MidCap Credit Facility

On March 26, 2018 (“MidCap Closing Date”) we entered into a Credit and Security Agreement (Term Loan) (the “MidCap Term Loan”) and a Credit and Security Agreement (Revolving Loan) (the “MidCap Revolving Loan” and together with the MidCap Term Loan (the “MidCap Credit Facility”) with MidCap Financial Trust, as agent. MidCap Financial Trust subsequently assigned its rights and obligations as agent to MidCap Funding IV Trust.

The MidCap Term Loan provides a secured term loan facility in an aggregate principal amount of up to $20.0 million. We borrowed the first advance of $7.0 million (“MidCap Tranche 1”) on the closing date. Under the terms of the MidCap Term Loan, the second advance of $13.0 million (“MidCap Tranche 2”) was to be available to us on or before September 30, 2019, subject to our satisfaction of certain conditions described in the MidCap Term Loan. As we did not satisfy these conditions, MidCap Tranche 2 was not made available to us for borrowing.

MidCap Tranche 1 was used to repay in full all outstanding amounts and fees due under our Loan and Security Agreement dated August 2014 with Oxford Finance LLC and Silicon Valley Bank (the “Growth Term Loan”). The proceeds remaining from MidCap Tranche 1 are being used for working capital and general corporate purposes.

MidCap Tranche 1 bears interest at a floating rate equal to 7.25% per annum, plus the greater of (i) 1.25% or (ii) the one-month LIBOR. Interest on MidCap Tranche 1 is due and payable monthly in arrears and was calculated at a rate of 8.9% for interest accrued as of December 31, 2019. Principal on this term loan advance was payable in 36 equal monthly installments beginning April 1, 2020 until paid in full on March 1, 2023 prior to the Amendment (described below). Prepayments of the term loan under the MidCap Term Loan, in whole or in part, will be subject to early termination fees in an amount equal to 2.0% of principal prepaid if prepayment occurs after the first anniversary of the MidCap Closing Date but on or prior to the second anniversary of the MidCap Closing Date, and 1.0% of principal prepaid if prepayment occurs after the second anniversary of the MidCap Closing Date and prior to or on the third anniversary of the MidCap Closing Date. In connection with execution of the MidCap Term Loan, we paid MidCap a $100,000 origination fee. Upon termination of the MidCap Term Loan, we are required to pay an exit fee equal to 4.50% of the principal amount of all term loans advanced to us under the MidCap Term Loan.

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The MidCap Term Loan also required that we deliver subordination documents with respect to the QNAH Convertible Note, or that the QNAH Convertible Note otherwise be converted or prepaid, on or before June 30, 2018, and required us to deposit approximately $3.3 million into an escrow account by July 15, 2018 if neither event occurred by such date. As neither event occurred prior to June 30, 2018, we deposited approximately $3.3 million into an escrow account on July 11, 2018. Such escrowed funds will be released to us upon subsequent delivery of the requisite subordination documents or conversion of the QNAH Convertible Note, or as permitted under the terms of the Amendment (described below). If neither delivery of the subordination documents or conversion of the QNAH Convertible Note occurs or the escrowed funds are not provided to us in accordance with the terms of the Amendment, such funds will be applied by the escrow agent to repay in full the QNAH Convertible Note at maturity (or in connection with a prepayment at the direction of the Company after September 1, 2020), subject to (i) our having at least $18.0 million of unrestricted cash and cash equivalents and (ii) there being no default under the MidCap Credit Facility.

The MidCap Revolving Loan provides a secured revolving credit facility in an aggregate principal amount of up to $2.0 million. We may request an increase in the total commitments under the MidCap Revolving Loan by up to an additional $8.0 million, subject to agent and lender approval and the satisfaction of certain conditions. Availability of the revolving credit facility under the MidCap Revolving Loan will be based upon a borrowing base formula and periodic borrowing base certifications valuing certain of our accounts receivable and inventory, as reduced by certain reserves, if any. The proceeds of any loans under the MidCap Revolving Loan may be used for working capital and general corporate purposes.

Loans under the MidCap Revolving Loan accrue interest at a floating rate equal to 4.25% per annum, plus the greater of (i) 1.25% or (ii) the one-month LIBOR. Accrued interest on the revolving loans will be paid monthly and revolving loans may be borrowed, repaid and re-borrowed until March 1, 2023, when all outstanding amounts must be repaid. Subject to certain exceptions, termination or permanent reductions of the revolving loan commitment under the MidCap Revolving Loan will be subject to termination fees in an amount equal to 2.0% of the commitment amount terminated or reduced if such termination or reduction occurs after the first anniversary of the MidCap Closing Date but on or prior to the second anniversary of the MidCap Closing Date, and 1.0% of the commitment amount terminated or reduced if such termination or reduction occurs after the second anniversary of the MidCap Closing Date and prior to or on the third anniversary of the MidCap Closing Date.

In connection with the MidCap Revolving Loan, we are required to pay customary fees, including an origination fee of 0.50% of the original commitment amount at closing (and an equivalent origination fee with respect to any increased commitments at the time of the applicable increase), a monthly unused line fee of 0.50% per annum based upon the average daily unused portion of the revolving credit facility and a monthly collateral management fee of 0.50% per annum based upon the average daily used portion of the revolving credit facility. We are also required to maintain a minimum drawn balance of not less 20% of availability under the revolving line. If we do not maintain such minimum drawn balance, it is required to pay monthly interest and fees as if an amount equal to 20% of availability had been drawn down under the revolving line.

Our obligations under the MidCap Credit Facility are secured by a security interest in substantially all of our assets, including intellectual property. Additionally, our future subsidiaries may be required to become co-borrowers or guarantors under the MidCap Credit Facility.

The MidCap Credit Facility contains customary affirmative covenants and customary negative covenants limiting our ability and the ability of our subsidiaries to, among other things, dispose of assets, undergo a change in control, merge or consolidate, make acquisitions, incur debt, incur liens, pay dividends, repurchase stock and make investments, in each case subject to certain exceptions.

The MidCap Credit Facility also contains customary events of default relating to, among other things, payment defaults, breaches of covenants, a material adverse change, delisting of our common stock, bankruptcy and insolvency, cross defaults with certain material indebtedness and certain material contracts, judgments, and inaccuracies of representations and warranties. Upon an event of default, agent and the lenders may declare all or a portion of our outstanding obligations to be immediately due and payable and exercise other rights and remedies provided for under the agreement. During the existence of an event of default, interest on the obligations could be increased by 3.0%.

In March 2018, we granted the lender ten-year warrants to purchase 18,123 shares of our common stock at $7.73 per share as a result of Tranche 1. The fair value of the warrants on the date of issuance was approximately $74,000, determined using the Black-Scholes option-pricing model, and was recorded as a discount to the MidCap Term Loan.

In February 2020, we entered into an amendment to the MidCap Credit Facility (the “Amendment”). The Amendment extended the interest-only payments on the term loan advances by an additional 11 months, with principal on each term loan advance payable in 25 equal monthly installments beginning March 1, 2021, until paid in full on March 1, 2023. The Amendment also allows for the extension of the interest-only period by an additional four months, with principal on each term loan advance then payable in 21 equal monthly installments beginning July 1, 2021, if certain revenue milestones are achieved for the 12-month period ending on December 31, 2020.

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In addition to the extension of the interest-only period, the Amendment (i) permits the use of the $3.3 million of escrowed funds previously deposited for repayment of the QNAH Convertible Note, subject to such repayment not being made before September 1, 2020, us having at least $18.0 million of unrestricted cash and cash equivalents and there being no default under the MidCap Term Loan or the MidCap Revolving Loan and (ii) includes a grant of a security interest in our intellectual property, effective as of the date of the Amendment.

The London interbank offered rate (“LIBOR”), which is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally, is currently scheduled to be phased out in 2021. Before LIBOR is phased out, we will need to amend the MidCap Credit Facility to replace LIBOR with a new reference rate, which has yet to be established. The consequences of this amendment cannot be entirely predicted but could result in higher interest rates on our borrowings under the MidCap Credit Facility.

Development and Component Supply Agreement with Illumina, Inc.

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

In April 2019, we entered into the First Amendment to the Restated Agreement (the “First Amendment”) with Illumina, effective April 3, 2019. The First Amendment expands the scope of the Field defined in the Restated Agreement to include diagnostic testing in humans for (i) autoimmune disorders and diseases, (ii) cardiovascular disorders and diseases, and (iii) fibrosis disorders and diseases ((i)-(iii) together, the “Other Fields”). We have continued the development plans that have been previously entered into under the Restated Agreement, and we may, at our discretion, submit additional development plans for IVD test kits in the Field to Illumina for its approval, not to be unreasonably withheld. In addition, Illumina will consider requests for additional development plans for IVD test kits in the Other Fields in good faith, but Illumina may accept or reject such requests in its sole and absolute discretion.

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

QIAGEN Agreements

Governing Agreement

In November 2016, we entered the Governing Agreement with QML. The Governing Agreement created a framework for the companies to combine their technological and commercial strengths to offer biopharmaceutical companies a complete NGS-based solution for the development, manufacture and commercialization of companion diagnostic assays. Under the Governing Agreement, the parties jointly sought companion diagnostic programs with biopharmaceutical companies, whereby QML entered into sponsor project agreements with interested biopharmaceutical companies for specified projects, and we and QML entered into statements of work, that set forth the rights and obligations of each party with respect to each project. We entered into three statements of work under the Governing Agreement since its initiation, of which two remained active as of December 31, 2019.

In November 2019, we terminated the Governing Agreement, effective immediately, as a result of QML’s material breach of the Governing Agreement. Our termination of the Governing Agreement did not terminate active statements of work under the Governing Agreement. For additional information relating to the statements of work associated with our Governing Agreement, see Item 8, “Notes to Consolidated Financial Statements.”

QNAH Convertible Note Agreement

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

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Third-Party Coverage and Reimbursement

Clinical laboratories acquire our instrumentation through a capital purchase, capital lease or reagent purchasing agreement. These laboratories offer their customers a menu of testing services using our IVD test kits or their LDTs, which they may develop using components they purchase from us, or a combination of both. Our customers generate revenue for these testing services by collecting payments from third-party payors, including public and private payors, as well as patient co-payments.

United States

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

Genomic Sequencing Procedures.

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

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

Our customers may use our products, if approved, and subject to regulatory limitations, to offer testing services that provide an analysis of 5‑50 genes as well as 51 or more genes. In October 2014, CMS released its preliminary determinations regarding the method for determining 2015 payment rates for new codes under the clinical laboratory fee schedule. CMS recommended that payment rates for GSPs be determined through a process known as gapfill rather than by crosswalking to allow CMS and its contractors to gather information about the manner in which the tests are performed and the resources necessary to provide them, so that ultimately CMS can set an appropriate payment rate for these tests. In the gapfill process, the local MACs determine the appropriate fee schedule amounts in the first year, and CMS calculates a national payment rate based on the median of these local fee schedule amounts in the second year. Gapfill pricing for CPTs 81445 and 81450 for the assessment of 5-50 genes in solid and liquid tumors, respectively, is set at $598 and $692, respectively, as of December 31, 2019. CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors is $2,920.

In 2018, CMS released its NCD for reimbursement of CDx tests in oncology. We believe this was a very important event as many of the diagnostic assays that we are in the process of developing are expected to be oncology CDx tests which would be addressed in this NCD.

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

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Outside the United States

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

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

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

Government Regulation – Medical Device Regulations

United States

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

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

Device Classification

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

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

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

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

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

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

The PMA Process

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

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

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

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

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If the FDA evaluation of a PMA is favorable, the FDA will issue either an approval letter, or an approvable letter, which usually contains several conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA letter authorizing commercial marketing of the device, subject to the conditions of approval and the limitations established in the approval letter. If the FDA’s evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional analytical studies or clinical studies are necessary, in which case approval of the PMA submission may be delayed for several months or years while the analytical studies and/or trials are conducted and data are submitted in an amendment to the PMA.

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

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

Post-Approval Requirements

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

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

Research Use Only

An RUO product is one that is not intended for clinical diagnostic use and must be labeled “For Research Use Only. Not for use in diagnostic procedures.” Products that are intended for research use only and are properly labeled as RUO are exempt from compliance with the FDA requirements discussed above, including the approval or clearance and most QSR requirements. A product labeled RUO but intended to be used diagnostically may be viewed by the FDA as adulterated and misbranded under the FDC Act and is subject to FDA enforcement activities. The FDA may consider the totality of the circumstances surrounding distribution and use of an RUO product, including how the product is marketed, when determining its intended use. In November 2013 the FDA issued a guidance document entitled “Distribution of In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only” (the “RUO Guidance”) which highlights the FDA’s interpretation that distribution of RUO products with any labeling, advertising or promotion that suggests that clinical laboratories can validate the test through their own procedures and subsequently offer it for clinical diagnostic use as a laboratory developed test is in conflict with RUO status. The RUO Guidance further articulates the FDA’s position that any assistance offered in performing clinical validation or verification, or similar specialized technical support, to clinical laboratories, conflicts with RUO status.

European Union

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

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

Other International

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

Government Regulation – Fraud and Abuse and Other Healthcare Regulation

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

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Federal Anti-Kickback Statute

The Federal Anti-Kickback Statute prohibits persons or entities from knowingly and willfully soliciting, offering, receiving or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in-kind, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, or for the purchasing, leasing, ordering, or arranging for or recommending, any good, facility, service or item for which payment may be made in whole or in part under federal healthcare programs, such as the Medicare and Medicaid programs. The Federal Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. The term “remuneration” expressly includes kickbacks, bribes, or rebates and has been broadly interpreted to include anything of value, including for example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payments, ownership interests and providing anything at less than its fair market value.

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

Federal Civil False Claims Act

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

Federal Physician Self-Referral Prohibition

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

Federal Civil Monetary Penalties Statute

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

Health Insurance Portability and Accountability Act of 1996

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

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In addition, HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH”) and their implementing regulations established uniform standards for covered entities, which are certain healthcare providers, health plans and healthcare clearinghouses, as well as their business associates that perform services for them that involve the creation, use, maintenance or disclosure of, individually identifiable health information, governing the conduct of specified electronic healthcare transactions and protecting the security and privacy of protected health information. Among other things, HITECH also created four new tiers of civil monetary penalties and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions. The EU has established its own data security and privacy legal framework, including but not limited to Directive 95/46/EC (“Data Protection Directive”). The Data Protection Directive was replaced in May 2018 with the recently adopted European General Data Protection Regulation (“GDPR”), which contains new provisions specifically directed at the processing of health information, higher sanctions and extra-territoriality measures intended to bring non-EU companies under the regulation. Over time we may expand our business operations to include additional operations in the EU. With such expansion, we would be subject to increased governmental regulation, including the GDPR, in the EU countries in which we operate.

The Federal Physician Payments Sunshine Act

The Federal Physician Payments Sunshine Act requires certain manufacturers of drugs, devices, biologics and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program, with certain exceptions, to report annually to CMS, information related to “payments or other transfers of value” provided to physicians (defined to include doctors, dentists, optometrists, podiatrists and chiropractors) and teaching hospitals, and applicable manufacturers and group purchasing organizations to report annually to CMS ownership and investment interests held by physicians, as defined above, and their immediate family members. Beginning in 2022, applicable manufacturers also will be required to report such information regarding payments and transfers of value provided, as well as ownership and investment interests held, during the previous year to physician assistants, nurse practitioners, clinical nurse specialists, certified nurse anesthetists and certified nurse-midwives. Failure to submit timely, accurately and completely the required information for all payments, transfers of value and ownership or investment interests may result in significant civil monetary penalties.

State Law Equivalents

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

California recently enacted legislation that has been dubbed the first “GDPR-like” law in the United States. Known as the California Consumer Privacy Act (“CCPA”), it creates new individual privacy rights for consumers (as that word is broadly defined in the law) and places increased privacy and security obligations on entities handling personal data of consumers or households. The CCPA became effective January 1, 2020, and requires covered companies to provide new disclosures to California consumers, provide such consumers new ways to opt-out of certain sales of personal information, and allows for a new cause of action for data breaches.

Healthcare Reform

In March 2010, President Obama enacted the ACA, which is substantially changing healthcare financing and delivery by both governmental and private insurers and is significantly impacting the medical device industry. The ACA’s provisions of importance to our business include, but are not limited to, a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, which since has been permanently eliminated by the 2020 federal spending package.

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There remain judicial and Congressional challenges to certain aspects of the ACA, as well as efforts by the Trump administration to repeal or replace certain aspects of the ACA. Since January 2017, President Trump has signed two Executive Orders and other directives designed to delay the implementation of certain provision of the ACA and otherwise circumvent some of the requirements for health insurance mandated by the ACA. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the ACA. While Congress has not passed comprehensive repeal legislation, two bills affecting the implementation of certain taxes under the ACA have been signed into law. The Tax Cuts and Jobs Act of 2017 (the “Tax Act”) includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the ACA on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”. Additionally, the 2020 federal spending package permanently eliminated, effective January 1, 2020, the ACA-mandated medical device tax and “Cadillac” tax on high-cost employer-sponsored health coverage and, effective January 1, 2021, also eliminates the health insurer tax. On December 14, 2018, a Texas U.S. District Court Judge ruled that ACA is unconstitutional in its entirety because the “individual mandate” was repealed by Congress as part of the Tax Act. Additionally, on December 18, 2019, the U.S. Court of Appeals for the 5th Circuit upheld the District Court ruling that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the ACA are invalid as well. It is unclear how this decision, future decisions, subsequent appeals, and other efforts to repeal and replace ACA will impact ACA.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following the passage of other legislative amendments, including the Bipartisan Budget Act of 2018, will stay in effect through 2029 unless additional Congressional action is taken. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

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

The Foreign Corrupt Practices Act

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

Employees

Our ability to retain current talent and recruit new employees into our Company is a critical factor in our continued growth and performance improvement. We continue to initiate programs to promote our organizational culture and to identify the best possible new talent as the organization grows and new positions are made available. As of December 31, 2019, we had 108 full-time and four part-time employees, of which 18 are employed in administration, 25 in manufacturing and operations, 35 in research and development, five in regulatory and quality affairs, and 29 in sales and marketing. Of these employees, 11 were located in Europe and all others were located in the United States. We believe that our success will depend, in part, on our ability to attract and retain qualified personnel. We have never experienced a work stoppage due to labor difficulties and believe that our relations with our employees are good. None of our U.S. employees are represented by labor unions. Collective bargaining is established by law in France. We and our French employees have agreed to the terms of the applicable collective bargaining agreements.

Corporate Information

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

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

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an emerging growth company until December 31, 2020. We refer to the Jumpstart Our Business Startups Act of 2012 in this Annual Report on Form 10-K as the “JOBS Act,” and references to “emerging growth company” have the meaning associated with it in the JOBS Act.

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

Item 1A. Risk Factors.

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

Risks Related to our Business and Strategy

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

We have incurred losses since our inception and expect to incur losses in the future. We incurred net losses of $19.3 million and $16.5 million for the years ended December 31, 2019 and 2018, respectively. As of December 31, 2019, we had an accumulated deficit of $170.3 million. We expect that our losses will continue for the foreseeable future as we will be required to invest significant additional funds to support product development, including development of new proprietary HTG EdgeSeq panels and products, and the commercialization of our HTG EdgeSeq system and proprietary consumables. We also expect that our selling, general and administrative expenses will continue to increase due to the additional costs associated with market development activities and expanding our staff to sell and support our products and services. Our ability to achieve or, if achieved, sustain profitability is based on numerous factors, many of which are beyond our control, including the market acceptance of our products and services, competitive product development and our market penetration and margins. We may never be able to generate sufficient revenue to achieve or, if achieved, sustain profitability.

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

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

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If our HTG EdgeSeq system and proprietary profiling panels fail to achieve and sustain sufficient market acceptance, or we are not able to continue to expand our service or collaborative relationships with biopharmaceutical customers, either directly or through a collaboration partner, we will not generate expected revenue, and our prospects may be harmed.

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

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

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

As a result of our termination of the Governing Agreement in November 2019, we no longer have a commercialization partner for the development, manufacture and commercialization of companion diagnostics for biopharmaceutical companies. Although the termination of the Governing Agreement does not preclude us from working with QML in the future, either party may be unwilling to partner with the other, and we may be unable to establish a partnering relationship with another suitable company for the development, manufacture, marketing and/or commercialization of companion diagnostic assays on acceptable terms, or at all. If we are unable to establish such a relationship with another company, our efforts to develop, manufacture and commercialize companion diagnostic assays may be significantly delayed and limited in scale, or may not occur at all. In addition, we do not know whether we will be able to enter into new collaborative arrangements with biopharmaceutical company customers on an independent basis. Any of these events could limit our diagnostic test sales and revenues and have a material adverse effect on our business, operating results and financial condition.

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

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

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Numerous other factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual operating results. For example, three customers accounted for 24%, 22% and 19% of our revenue, respectively, for the year ended December 31, 2019, and three customers accounted for 29%, 26% and 10% of our accounts receivable balance as of December 31, 2019. If orders from our top customers are discontinued and we are unable to establish new collaboration projects with biopharmaceutical companies, our revenue in future periods may materially decrease. Fluctuations in our operating results may make financial planning and forecasting difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. Factors that may contribute to fluctuations in our operating results include many of the risks described under the caption “Risk Factors – Risks Related to Our Business and Strategy” of this report. In addition, one or more of such factors may cause our revenue or operating expenses in one period to be disproportionately higher or lower relative to the others. Our products involve a significant capital commitment from our customers or may depend on customer studies that have variable or indefinite timelines and accordingly, involve a lengthy sales cycle. We may expend significant effort in attempting to make a particular sale, which may be deferred by the customer or never occur. Accordingly, comparing our operating results on a period-to-period basis may not be meaningful, and investors should not rely on our past results as an indication of our future performance. If such fluctuations occur or if our operating results deviate from our expectations or the expectations of investors or securities analysts, our stock price may be adversely affected.

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

Our sales process involves numerous interactions with multiple individuals within any given organization, and often includes in-depth analysis by potential customers of our products (where in some instances we will provide a demonstration unit for their use and evaluation), performance of proof-of-principle studies, preparation of extensive documentation and a lengthy review process. As a result of these factors, the capital investment required in purchasing our instrument and the budget cycles of our customers, the time from initial contact with a customer to our receipt of a purchase order can vary significantly and be up to 12 months or longer. Given the length and uncertainty of our sales cycle, we have in the past experienced, and likely will in the future experience, fluctuations in our product and product-related services revenue on a period-to-period basis. In addition, any failure to meet customer expectations could result in customers choosing to retain their existing systems or service providers or to purchase systems or services other than ours. The revenue that we expect to earn from our collaborative development services are also subject to an extended, variable timeline based on each project agreement, which will likely result in fluctuations in our collaborative development services revenue on a period-to-period basis as well.

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

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

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

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

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

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

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

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

We have initiated early development of a comprehensive whole transcriptome assay, which we are building for clinical use and which we believe will serve as our anchor product not only for RUO profiling but also for our proprietary breast diagnostic products. In addition, we believe this product will serve as a universal CDx platform for gene expression profiling for our biopharmaceutical company customers. Moreover, we believe this product will allow us to expand our product offerings outside of oncology and autoimmune into markets such as transplant and diabetes. We cannot guarantee that we will be able to successfully develop a comprehensive whole transcriptome assay or that it will have the benefits that we anticipate. If we are unsuccessful at developing this assay or it does not provide the benefits that we anticipate, we may be limited in the breadth of additional products we can offer in the future, which could impact our future revenue and profits.

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

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

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

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

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

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

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

If regulatory limitations are placed on our diagnostic products our business and growth will be harmed.

In many jurisdictions, including the United States, we are currently limited to marketing our HTG EdgeSeq system and proprietary profiling panels for research use only, which means that we cannot make any diagnostic or clinical claims for those products in those jurisdictions.

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

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

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

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

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

A key component of our strategy is the development of companion diagnostic products designed to determine the appropriate patient population for administration of a particular therapeutic to more successfully treat a variety of illnesses. Prior to the termination of the Governing Agreement in November 2019, we had an exclusive arrangement with QML to develop certain companion diagnostic products for biopharmaceutical companies under the Governing Agreement. We may now choose to develop companion diagnostic products independently or with a collaboration partner. Successfully developing a companion diagnostic product depends both on regulatory approval for administration of the therapeutic, as well as regulatory approval of the associated diagnostic product. Even if we are successful in developing products that would be useful as companion diagnostic products, and potentially receive regulatory approval for such products, the biopharmaceutical companies that develop the corresponding therapeutics may ultimately be unsuccessful in obtaining regulatory approval for any such therapeutic, or, even if successful, select a competing technology to use in their regulatory submission instead of ours. The development, especially the independent development, of companion diagnostic products requires a significant investment of working capital which may not result in any future income. This could require us to raise additional funds which could dilute our current investors or could impact our ability to continue our operations in the future.

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

For the year ended December 31, 2019, approximately 34% of our revenue was generated from sales originated by customers located outside of the United States, compared to 69% for year ended December 31, 2018. We expect that a percentage of our future revenue will continue to come from international sources, and we expect to expand our overseas operations and develop opportunities in additional areas. Engaging in international business involves a number of difficulties and risks, including:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We have relied, and expect to continue to rely, on strategic development collaborations and licensing agreements with third parties to develop or in-license technologies based on which products or services we may develop or offer. We have entered into agreements with third parties to facilitate or enable our development of assays, and ultimately diagnostic tests, to aid in the diagnosis of oncology diseases, such as breast cancer and melanoma, and other diseases. We intend to enter into additional similar agreements with life sciences companies, biopharmaceutical companies and other researchers for future diagnostic products. However, we cannot guarantee that we will enter into any additional agreements. In particular, our life sciences research or biopharmaceutical customers are not obligated to collaborate with us or license technology to us, and they may choose to develop diagnostic products themselves or collaborate with our competitors. Establishing development collaborations and licensing arrangements is difficult and time-consuming. Discussions may not lead to development collaborations or licenses on favorable terms, or at all. Potential collaborators or licensors may elect not to work with us based upon their assessment of our financial, regulatory or intellectual property position. To the extent that we enter new collaborative development or licensing agreements, they may never result in the successful development or commercialization of future tests or other products for a variety of reasons, including because our collaborators may not succeed in performing their obligations or may choose not to cooperate with us. We cannot control the amount and timing of our collaborators’ resources that will be devoted to performing their responsibilities under our agreements with them. Moreover, to the extent we agree to work exclusively with a party in a given area, our opportunities to collaborate with others would be limited. Even if we establish new relationships, they may never result in the successful development or commercialization of future tests or other products. Disputes with our collaborators could also impair our reputation or result in development delays, decreased revenues and litigation expenses.

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

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

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

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

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

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

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

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

Our business operations might be disrupted or adversely affected by catastrophic events.

We manufacture our consumable products and our HTG EdgeSeq system and perform our RUO profiling and collaborative development services in our Tucson, Arizona facilities. In addition, our Tucson facilities are the center for order processing, receipt of critical components of our HTG EdgeSeq instrument and shipping products to customers. We do not have redundant facilities. Damage or the inability to utilize our Tucson facilities and the equipment we use to perform research, development or services and manufacture our products could be costly, and we would require substantial lead-time to repair or replace this facility and equipment. The Tucson facilities may be harmed or rendered inoperable by natural or man-made disasters, including flooding, wind damage, power spikes and power outages, which may render it difficult or impossible for us to perform these critical functions for some period of time. The inability to manufacture consumables or instruments, process customer samples, perform development services or ship products to customers for even a short period of time may result in the loss of customers or harm our reputation, and we may be unable to regain those customers in the future. Although we possess insurance for damage to our property and the disruption of our business, this insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all. In addition, natural disasters or other catastrophic events in various parts of the world, including interruptions in the supply of natural resources, political and governmental changes, disruption in transportation networks or delivery services, severe weather conditions, wildfires and other fires, explosions, actions of animal rights activists, terrorist attacks, earthquakes, wars and public health issues could disrupt our operations or those of our collaborators, contractors and vendors or contribute to unfavorable economic or other conditions that could adversely impact us.

Public health epidemics, pandemics or outbreaks, including the recent coronavirus pandemic, could adversely affect our business.

Our business, including our workforce, supply chain and customer base, may be adversely affected by the effects of health epidemics, including the recent outbreak of the novel strain of coronavirus (COVID-19) which has been declared a pandemic. As a result of health epidemics, including COVID-19, businesses may be shut down, supply chains can be interrupted, slowed, or rendered inoperable, and individuals can become ill, quarantined, or otherwise unable to work and/or travel due to health reasons or governmental restrictions.

The outbreak of COVID-19 has caused several countries to implement quarantines and/or significant restrictions on travel. In addition, certain affected regions, including several states within the United States, have implemented work restrictions that prohibit many employees from going to work. Moreover, the COVID-19 pandemic has resulted in business closures and a substantial reduction in economic activity in the United States and worldwide.

Governmental mandates may require forced shutdowns of our facilities for extended or indefinite periods. In addition, these widespread outbreaks of illness could adversely affect our workforce resulting in serious health issues and absenteeism. Pandemic outbreaks, including the coronavirus, could also substantially interfere with general commercial activity related to our supply chain and customer base, which could have a material adverse effect on our financial condition, results of operations, business, or prospects. Restrictions resulting from the COVID-19 pandemic may disrupt our supply chain or limit our ability to obtain sufficient materials for our consumables or instruments and may disrupt our ability to process customer samples or perform collaborative development services. Further, if our customers’ businesses are similarly affected, they might delay or reduce purchases from us or collaborative development projects with us, which could adversely affect our results of operations.

While significant uncertainty remains as to the potential impact of the COVID-19 pandemic on our operations, and on the global economy as a whole, we believe it is likely that the COVID-19 outbreak will have a negative impact on our product and product‑related services revenue and collaborative development services revenue in 2020. We believe this negative impact will be primarily demand-side driven as our customers experience disruptions in their own businesses from the pandemic. However, it is possible that the COVID-19 pandemic will also impact our workforce, supply chains or distribution networks or otherwise impact our ability to conduct sample processing services and custom assay development services and our ability to provide collaborative development services for companion diagnostic development programs.

The ultimate impact of the COVID-19 pandemic or a similar health epidemic is highly uncertain and subject to change. We do not yet know the full extent of potential delays or impacts on our business, our customers’ businesses, healthcare systems or the global economy as a whole. However, these effects could have a material adverse impact on our operations, financial position and liquidity.

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

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

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

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

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

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

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

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

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

Pursuant to the terms of an asset purchase agreement with NuvoGen, we agreed to annually pay NuvoGen the greater of $400,000 or 6% of our yearly revenue until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15.0 million. To date, we have paid NuvoGen approximately $9.4 million. Payments to NuvoGen will result in a reduction in our working capital as we continue to make payments on this obligation

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

Under the MidCap Credit Facility, our interest rate on borrowed amounts is dependent on LIBOR. LIBOR, which is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally, is currently scheduled to be phased out in 2021. Before LIBOR is phased out, we may need to renegotiate the MidCap Credit Facility to replace LIBOR with a new reference rate, which has yet to be established. The consequences of these developments cannot be entirely predicted, but could result in higher interest rates on our loans under the MidCap Credit Facility. We cannot provide assurance that future interest rate changes will not have a material negative impact on our business, financial position, or operating results.

Further, the MidCap Credit Facility requires us, and any debt arrangements we may enter into in the future may require us, to comply with various covenants that limit our ability to, among other things:

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

Changes in tax laws or regulations that are applied adversely to us or our customers may have a material adverse effect on our business, cash flow, financial condition or results of operations.

New income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time, which could adversely affect our business operations and financial performance. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. For example, the Tax Act enacted many significant changes to the U.S. tax laws. Future guidance from the Internal Revenue Service and other tax authorities with respect to the Tax Act may affect us, and certain aspects of the Tax Act could be repealed or modified in future legislation. In addition, it is uncertain if and to what extent various states will conform to the Tax Act or any newly enacted federal tax legislation. Changes in corporate tax rates, the realization of net deferred tax assets relating to our operations, the taxation of foreign earnings, and the deductibility of expenses under the Tax Act or future reform legislation could have a material impact on the value of our deferred tax assets, could result in significant one-time charges, and could increase our future U.S. tax expense.

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Our ability to use net operating loss carryforwards and certain other tax attributed may be limited.

As of December 31, 2019, we had federal net operating loss carryforwards (“NOLs”) to offset future taxable income of approximately $158.2 million, of which $121.8 million will begin to expire in 2021 if not utilized, while the remainder can be carried forward indefinitely. A lack of future taxable income would adversely affect our ability to utilize these NOLs. Under the Tax Act, federal NOLs incurred in taxable years ending after December 31, 2017, may be carried forward indefinitely, but the deductibility of federal NOLs generated in tax years beginning before January 1, 2018, is limited. It is uncertain if and to what extent various states will conform to the Tax Act. In addition, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the “IRC”), and corresponding provisions of state law, a corporation that undergoes an “ownership change” (generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period) is subject to limitations on its ability to utilize its pre-ownership change NOL carryforwards and certain other pre-ownership change tax attributes to offset post-ownership change income or taxes. We believe we may have already experienced one or more ownership changes and may in the future experience one or more additional ownership changes, and thus, our ability to utilize pre-ownership change NOL carryforwards and other pre-ownership change tax attributes to offset post-ownership change income or taxes may be limited. Such limitations may cause a portion of our NOL and credit carryforwards to expire before we are able to utilize them. In addition, at the state level, there may be periods during which the use of NOL carryforwards is suspended or otherwise limited, which could accelerate or permanently increase state taxes owed. We have recorded a full valuation allowance related to our NOLs and other deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets.

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

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

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

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

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

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

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

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

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

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

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

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

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

Changes in funding for the FDA, the SEC and other government agencies could hinder their ability to hire and retain key leadership and other personnel, prevent new products and services from being developed or commercialized in a timely manner or otherwise prevent those agencies from performing normal functions on which the operation of our business may rely, which could negatively impact our business.

The ability of the FDA to review and approve new products can be affected by a variety of factors, including government budget and funding levels, ability to hire and retain key personnel and accept payment of user fees, and statutory, regulatory, and policy changes. Average review times at the agency have fluctuated in recent years as a result. In addition, government funding of the SEC

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and other government agencies on which our operations may rely, including those that fund research and development activities is subject to the political process, which is inherently fluid and unpredictable.

Disruptions at the FDA and other agencies may also slow the time necessary for new drugs to be reviewed and/or approved by necessary government agencies, which would adversely affect our business. For example, over the last several years, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA and the SEC, have had to furlough critical FDA, SEC and other government employees and stop critical activities. If a prolonged government shutdown occurs, it could significantly impact the ability of the FDA to timely review and process our regulatory submissions, which could have a material adverse effect on our business. Further, future government shutdowns could impact our ability to access the public markets and obtain necessary capital in order to properly capitalize and continue our operations.

The withdrawal of the United Kingdom, from the European Union, commonly referred to as “Brexit,” may adversely impact our ability to obtain regulatory approvals of our product candidates in the European Union, result in restrictions or imposition of taxes and duties for importing our product candidates into the European Union, and may require us to incur additional expenses in order to develop, manufacture and commercialize our product candidates in the European Union.

Following the result of a referendum in 2016, the United Kingdom left the European Union on January 31, 2020, commonly referred to as Brexit. Pursuant to the formal withdrawal arrangements agreed between the United Kingdom and the European Union, the United Kingdom will be subject to a transition period until December 31, 2020, or the Transition Period, during which EU rules will continue to apply. Negotiations between the United Kingdom and the European Union are expected to continue in relation to the customs and trading relationship between the United Kingdom and the European Union following the expiry of the Transition Period.

Since a significant proportion of the regulatory framework in the United Kingdom applicable to our business and our product candidates is derived from EU directives and regulations, Brexit, following the Transition Period, could materially impact the regulatory regime with respect to the development, manufacture, importation, approval and commercialization of our product candidates in the United Kingdom or the European Union. For example, as a result of the uncertainty surrounding Brexit, the EMA relocated to Amsterdam from London. Following the Transition Period, the United Kingdom will no longer be covered by the centralized procedures for obtaining EU-wide marketing authorization from the EMA and, unless a specific agreement is entered into, a separate process for authorization of drug products, including our product candidates, will be required in the United Kingdom, the potential process for which is currently unclear. Any delay in obtaining, or an inability to obtain, any marketing approvals, as a result of Brexit or otherwise, would prevent us from commercializing our product candidates in the United Kingdom or the European Union and restrict our ability to generate revenue and achieve and sustain profitability. In addition, we may be required to pay taxes or duties or be subjected to other hurdles in connection with the importation of our product candidates into the European Union, or we may incur expenses in establishing a manufacturing facility in the European Union in order to circumvent such hurdles. If any of these outcomes occur, we may be forced to restrict or delay efforts to seek regulatory approval in the United Kingdom or the European Union for our product candidates, or incur significant additional expenses to operate our business, which could significantly and materially harm or delay our ability to generate revenues or achieve profitability of our business. Any further changes in international trade, tariff and import/export regulations as a result of Brexit or otherwise may impose unexpected duty costs or other non-tariff barriers on us. These developments, or the perception that any of them could occur, may significantly reduce global trade and, in particular, trade between the impacted nations and the United Kingdom.

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

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

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

Our business requires manipulating, analyzing and storing large amounts of data. In addition, we rely on an enterprise software system to operate and manage our business. We also maintain personally identifiable information about our employees. Our business therefore depends on the continuous, effective, reliable and secure operation of our computer hardware, software, networks, Internet servers and related infrastructure. To the extent that our hardware and software malfunction or access to our data by internal personnel is interrupted, our business could suffer. The integrity and protection of our employee and company data is critical to our business and employees have a high expectation that we will adequately protect their personal information. The regulatory environment governing information, security and privacy laws is increasingly demanding and continues to evolve. Maintaining compliance with applicable

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security and privacy regulations may increase our operating costs. Although our computer and communications software are protected through physical and software safeguards, it is still vulnerable to natural or man-made hazards, such as fire, storm, flood, power loss, wind damage, telecommunications failures, physical or software break-ins, software viruses and similar events. We have experienced specific instances of cyber breaches in the past, and there could be unauthorized access, disclosure and use of non-public information in the future. The techniques used by criminal elements to attack computer systems are sophisticated, change frequently and may originate from less regulated and remote areas of the world. As a result, we may not be able to address these techniques proactively or implement adequate preventative measures. If our computer systems are compromised, we could be subject to fines, damages, litigation and enforcement actions, and we could lose trade secrets, the occurrence of which could harm our business. In addition, any sustained disruption in internet access provided by other companies could harm our business.

Risks Related to Government Regulation and Diagnostic Product Reimbursement

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

Before we begin to label and market our products for use as clinical diagnostics in the United States, including as companion diagnostics, unless an exemption applies, we will be required to obtain either 510(k) clearance or PMA from the FDA. In addition, we may be required to seek FDA clearance for any changes or modifications to our products that could significantly affect their safety or effectiveness or would constitute a change in intended use. The 510(k) clearance processes can be expensive, time-consuming and uncertain. In addition to the time required to conduct clinical studies, if necessary, it generally takes from four to twelve months from submission of an application to obtain 510(k) clearance; however, it may take longer and 510(k) clearance may never be obtained. Even if the FDA accepts a 510(k) submission for filing, the FDA may request additional information or clinical studies during its review. Our ability to obtain additional regulatory clearances for new products and indications may be significantly delayed or may never be obtained. In addition, we may be required to obtain PMAs for new products or product modifications. The requirements of the more rigorous PMA process could delay product introductions and increase the costs associated with FDA compliance. As with all IVD products, the FDA reserves the right to redefine the regulatory path at the time of submission or during the review process and could require a more burdensome approach. Even if we were to obtain regulatory approval or clearance, it may not be for the uses we believe are important or commercially attractive, in which case we would not be permitted to market our product for those uses.

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

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

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

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

A significant change in the laws governing RUO products or how they are enforced may require us to change our business model in order to maintain compliance. For instance, in November 2013 the FDA issued a guidance document entitled “Distribution of In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only” (the “RUO Guidance”) which highlights

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

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

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

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

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

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

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

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

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reimbursement, require co-payments from patients or stop paying for our tests, which would reduce revenue for testing services based on our technology and demand for our diagnostic products.

The American Medical Association Current Procedural Terminology (“CPT”) Editorial Panel created new CPT codes that could be used by our customers to report testing for certain large-scale multianalyte genomic sequencing procedures (“GSPs”), including our diagnostic products, if approved. Effective January 1, 2015, these codes allow for uniform reporting of broad genomic testing panels using technology similar to ours. While these codes standardize reporting for these tests, coverage and payment rates for GSPs remain uncertain and we cannot guarantee that coverage and reimbursement for these tests will be provided in the amounts we expect, or at all. Initially, industry associations recommended that payment rates for GSPs be cross-walked to existing codes on the clinical laboratory fee schedule. On October 27, 2014, Centers for Medicare and Medicaid Services (“CMS”) issued preliminary determinations for 29 new molecular pathology codes, including the GSPs, of gapfill rather than crosswalking as recommended by the Association for Molecular Pathology. This means that local private Medicare Administrative Contractors, such as Palmetto, Novidian, Novitas and Cahaba, were instructed to determine the appropriate fee schedule amounts in the first year, and CMS calculated a national payment rate based on the median of those local fee schedule amounts in the second year. This process may make it more difficult for our customers to obtain coverage and adequate reimbursement for testing services using our diagnostic products. We cannot assure that CMS and other third-party payors will establish reimbursement rates sufficient to cover the costs incurred by our customers in using our clinical diagnostic products, if approved. On September 22, 2017, gapfill pricing was set for three CPT codes which our customers may potentially utilize to obtain reimbursement, subject to regulatory limitations, for the use of our products. CPTs 81445 and 81450, for the assessment of 5-50 genes in solid and liquid tumors, respectively, were set at $602 and $760, respectively, and remains the same as of December 31, 2019. Additionally, CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors was set at $2,920.

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

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

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

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

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

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

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

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

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

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

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

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governmental investigations or other actions or lawsuits stemming from a failure to comply with these laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of significant civil, criminal and administrative penalties, damages, monetary fines, disgorgement, imprisonment, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws, and curtailment of our operations. Any of these actions or investigations could result in substantial costs to us, including legal fees, and divert the attention of management from operating our business.

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

On April 1, 2014, the Protecting Access to Medicare Act of 2014 (“PAMA”) was signed into law, which, among other things, significantly altered the current payment methodology under the Medicare Clinical Laboratory Fee Schedule (“CLFS”). Effective January 1, 2018, the CLFS is based on weighted median private payor rates as required by PAMA. Under the law, starting January 1, 2016 and every three years thereafter (or annually in the case of advanced diagnostic lab tests), applicable clinical laboratories must report laboratory test payment data for each Medicare-covered clinical diagnostic lab test that it furnishes. The most recent data collection period was from January 1, 2019, through June 30, 2019 and was followed by a six-month validation period from July 1, 2019 through December 31, 2019. Thereafter, applicable laboratories will report their data between January 1, 2020 and March 31, 2020. The reported data must include the payment rate (reflecting all discounts, rebates, coupons and other price concessions) and the volume of each test that was paid by each private payor (including health insurance issuers, group health plans, Medicare Advantage plans and Medicaid managed care organizations). This data collection and data reporting cycle will be used to determine the CLFS payment rates for 2021 through 2023. The payment rate applies to laboratory tests furnished by a hospital laboratory if the test is separately paid under the hospital outpatient prospective payment system. It is still too early to predict the full impact on reimbursement for our products in development.

Also under PAMA, CMS is required to adopt temporary billing codes to identify new tests and new advanced diagnostic laboratory tests that have been cleared or approved by the FDA. For an existing test that is cleared or approved by the FDA and for which Medicare payment is made as of April 1, 2014, CMS is required to assign a unique billing code if one has not already been assigned by the agency. In addition to assigning the code, CMS was required to publicly report payment for the tests. We cannot determine at this time the full impact of the law, including its implementing regulations, on our business, financial condition and results of operations.

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

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. However, the future of the ACA is uncertain. There remain judicial and Congressional challenges to certain aspects of the ACA, as well as efforts by the Trump administration to repeal or replace certain aspects of the ACA. As a result, there have been delays in the implementation of, and action taken to repeal or replace, certain aspects of the ACA. Since January 2017, President Trump has signed two Executive Orders and other directives designed to delay the implementation of certain provisions of the ACA or otherwise circumvent some of the requirements for health insurance mandated by the ACA. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the ACA. While Congress has not passed comprehensive repeal legislation, it has enacted laws that modify certain provisions of the ACA. For example, the Tax Act includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the ACA on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”. In addition, the 2020 federal spending package permanently eliminated, effective January 1, 2020, the ACA-mandated medical device tax and “Cadillac” tax on high-cost employer-sponsored health coverage and, effective January 1, 2021, also eliminates the health insurer tax. On December 14, 2018, a Texas U.S. District Court Judge ruled that the ACA is unconstitutional in its entirety because the “individual mandate” was repealed by Congress as part of the Tax Act. Additionally, on December 18, 2019, the U.S. Court of Appeals for the 5th Circuit upheld the District Court ruling that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the ACA are invalid as well. It is unclear how this decision, future decisions, subsequent appeals,

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and other efforts to repeal and replace ACA will impact ACA and our business. We continue to evaluate the effect that the ACA and its possible repeal and replacement has on our business.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, then-President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following the passage of other legislative amendments, including the Bipartisan Budget Act of 2018, will stay in effect through 2029 unless additional Congressional action is taken. On January 2, 2013, then-President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

Various healthcare reform proposals have also emerged from federal and state governments. Changes in healthcare law or policy, such as the creation of broad test utilization limits for diagnostic products in general or requirements that Medicare patients pay for portions of clinical laboratory tests or services received, could substantially impact the sales of our tests, increase costs and divert management’s attention from our business. In addition, sales of our tests outside of the United States will subject us to foreign regulatory requirements, which may also change over time.

We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or in countries outside of the United States in which we may do business, or the effect any future legislation or regulation will have on us. The full impact of the ACA, as well as other laws and reform measures that may be proposed and adopted in the future, remains uncertain, but may continue the downward pressure on medical device pricing, especially under the Medicare program, and may also increase our regulatory burdens and operating costs, which could have a material adverse effect on our business operations.

Risks Related to Intellectual Property

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Risks Related to Being a Public Company

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

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

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

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

From time to time, the FASB, either alone or jointly with other organizations, promulgates new accounting principles that could have an adverse impact on our financial position, results of operations or reported cash flows. For example, in May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, and subsequently issued implementation guides (collectively, the “New Revenue Standard”). The New Revenue Standard superseded nearly all previous revenue recognition guidance under US GAAP and became effective for us beginning January 1, 2018. Our inability to adopt or implement any new accounting standard correctly, or to update or modify our internal controls as needed, by the mandated adoption dates could adversely affect our financial reporting obligations, corresponding regulatory compliance and/or investors’ confidence in us. Also, if we were to change our critical accounting estimates, including those related to the recognition of collaboration revenue and other revenue sources, our operating results could be significantly affected.

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

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

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

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

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

We are an “emerging growth company,” as defined in the JOBS Act, enacted in April 2012, and a “smaller reporting company,” as defined in the Exchange Act, and for as long as we continue to be an “emerging growth company” or a “smaller reporting company,” we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to “emerging growth companies” or “smaller reporting companies,” including, but not limited to, not being required to have our independent registered public accounting firm audit our internal control over financial reporting under Section 404 (for so long as we are an “emerging growth company”), reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements (for so long as we are an “emerging growth company” or a “smaller reporting company”), and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved (for so long as we are an “emerging growth company”). We will be an “emerging growth company” until December 31, 2020. We will be a “smaller reporting company” until the market value of our common stock that is held by non-affiliates exceeds $250.0 million as of the last business day of our most recently completed second fiscal quarter. We cannot predict if investors will find our common stock less attractive if we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may be more volatile.

Risks Related to Our Common Stock

We expect that our stock price will fluctuate significantly.

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

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

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

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

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

Pursuant to our 2014 Equity Incentive Plan (“2014 Plan”) our Board of Directors is authorized to grant stock options and other equity-based awards to our employees, directors and consultants. The number of shares available for future grant under the 2014 Plan will automatically increase on January 1 of each year by 4% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year, subject to the ability of our board of directors to take action to reduce the size of the increase in any given year. In addition, our Board of Directors approved the granting of rights to eligible employees to purchase shares of our common stock pursuant to our 2014 Employee Stock Purchase Plan (“ESPP”) beginning January 1, 2016. The number of shares of our common stock reserved for issuance under the ESPP will automatically increase on January 1 of each calendar year by the lesser of 1% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year and 195,000 shares, subject to the ability of our Board of Directors to take action to reduce the size of the increase in any given year. Currently, we plan to register the increased number of shares available for issuance under the 2014 Plan and ESPP each year. Increases in the number of shares available for future grant or purchase may result in additional dilution, which could cause our stock price to decline.

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

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

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

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

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

Our common stock is currently listed on The Nasdaq Capital Market under the symbol “HTGM.” In order to maintain this listing, we must continue to satisfy minimum financial and other continued listing requirements and standards. There can be no assurance that we will be able to continue to comply with the applicable listing standards. If we were not able to comply with applicable listing standards, our shares of common stock would be subject to delisting. The delisting of our common stock from trading on Nasdaq may have a material adverse effect on the market for, and liquidity and price of, our common stock and impair our ability to raise capital. Delisting from Nasdaq could also have other negative results, including, without limitation, the potential loss of confidence by customers and employees, the loss of institutional investor interest and fewer business development opportunities. In the event that our common stock is delisted from Nasdaq and is not eligible for quotation or listing on another market or exchange, trading of our common stock could be conducted only in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate price quotations for, our common stock, and there would likely also be a reduction in our coverage by securities analysts and the news media, which could cause the price of our common stock to decline further.

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

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

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

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

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

Item 1B. Unresolved Staff Comments.

None.

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Item 2. Properties.

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

In January 2019, we further amended the first lease to add approximately 7,000 square feet of additional administrative, manufacturing and laboratory space, effective August 15, 2019, and continuing through expiration of the lease in January 2021. In connection with this lease amendment, the landlord has agreed to fund certain leasehold improvements, of which approximately $22,000 was incurred through December 31, 2019, which will be amortized over the shorter of the useful life of the leasehold improvements or the remaining lease term. Base rent for the additional leased space will be approximately $6,800 per month, excluding reimbursement of landlord funded improvements, commencing on the date of occupancy and extending through the remaining term of the lease. Our landlord holds security deposits equal to a total of approximately $30,000. We expect to renew our Tucson leases on or before their expiration on terms similar to the expiring leases.

We also lease 4,800 square feet of administrative and development laboratory space in San Carlos, California, which we took occupancy on in April 2019. The initial term of this lease is 48 months, to expire in March 2023, with the option to extend the term for an additional 12 months. Base rent payable under this lease increases approximately 3% per year over the term of the lease from $21,600 per month in the first year to $23,616 per month in the final year of the lease, plus reimbursement of operating expenses to the landlord. Our landlord also holds a security deposit of $50,000 for this facility.

We believe that our existing facilities are adequate to meet our business requirements for the reasonably foreseeable future and that additional space will be available on commercially reasonable terms, if required.

Item 3. Legal Proceedings.

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

Item 4. Mine Safety Disclosures.

Not applicable.

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PART II

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

Market Information

Our common stock is traded on The Nasdaq Capital Market under the symbol “HTGM.” Trading of our common stock on The Nasdaq Stock Market commenced on May 6, 2015 in connection with our initial public offering.

On March 2, 2020, the last reported sale price of our common stock was $0.55 per share.

Holders

As of March 2, 2020, there were approximately 151 holders of record of our common stock. The actual number of stockholders is greater than this number of record holders and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees.

Dividends

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

Item 6. Selected Financial Data.

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

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

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

Overview

We are a commercial stage RNA platform-based life sciences company focused on advancing the promise of precision medicine. Our product and service solutions are based on our proprietary next-generation HTG EdgeSeq technology that enables full RNA profiling using a small amount of biological sample, in liquid or solid forms. Our menu of HTG EdgeSeq assays is automated on our HTG EdgeSeq platform, which applies genomic sequencing tools that generate gene expression data in a timely manner utilizing a simplified workflow for customers. We seek to leverage key business drivers in molecular profiling for biomarker analysis and diagnostics, including the acceleration of precision medicine, the migration of molecular testing to NGS-based applications, the movement to smaller and less invasive biopsies, the need for greater diagnostic sensitivity, the need to conform to challenging healthcare economics and the need for automation and an easily deployable workflow, including simplified bioinformatics. For example, these capabilities enable customers to extend the use of limited biological samples for retrospective analysis, gaining further understanding of the molecular drivers of disease with the goal of developing biomarker-driven targeted therapies. We also believe our HTG EdgeSeq technology can be used as a platform technology in clinical applications that will simplify, consolidate and reduce the cost of NGS-based diagnostic workflows and in commercialized CDx tests.

Our products include instrumentation, consumables, including assay kits, and software that, as an integrated system, automate sample processing and can quickly, robustly and simultaneously profile tens, hundreds or thousands of molecular targets from samples a fraction of the size required by many prevailing technologies. Our objective is to establish our solutions as the standard in molecular profiling, companion diagnostic development and molecular diagnostics, and to make their benefits accessible to all molecular labs from research to the clinic. We believe that our target customers desire high quality molecular profiling information in a multiplexed panel format from increasingly smaller and less invasive samples, with the ability to test and analyze such information locally to minimize turnaround time and cost.

In 2014, we launched our HTG EdgeSeq technology, which generates a molecular profiling library for gene expression profiling using NGS. Our HTG EdgeSeq assays are automated on our HTG EdgeSeq platform. Our innovative platform and menu of molecular profiling panels are being utilized in two complimentary ways in advancing precision health. Biopharmaceutical companies and other translational research centers utilize our technology to discover and validate biomarkers and develop molecular subtypes, which can identify patient populations most likely to respond to certain therapies. In addition to purchasing our technology for use in customer facilities, customers can also obtain the advantages of our proprietary technology through our service offerings. Pre-clinical services, including custom assay development and sample processing services provided by our Tucson-based VERI/O laboratory, allow customers the ability to more efficiently identify and validate biomarker signatures across their drug portfolios or patient cohorts. Our ISO 13485 2016 quality system and diagnostic development teams also partner with biopharmaceutical company customers to develop, manufacture and commercialize companion diagnostics. Although our initial focus is oncology, we offer customers a full solution from biomarker discovery to deployment of CDx tests across all disease states. Utilizing NGS as our method of detection provides our customers with the benefits of our highly multiplexed and extraction-free chemistry and the sensitivity and dynamic range of the sequencers, providing a powerful value proposition and complete workflow.

We have two primary sources of revenue: product and product-related services revenue from the sale of research use only (“RUO”) and CE/IVD marked profiling products, sample processing services and custom assay development services to biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for companion diagnostic development programs for biopharmaceutical companies.

Profiling product and product-related services revenue includes customer purchases of our HTG EdgeSeq instrument and related assay kits, development of custom RUO assay kits for customers and the use of our HTG EdgeSeq instrument and RUO assay kits to process samples on the customer’s behalf in our VERI/O laboratory. In addition, as of December 31, 2019, we sell two internally developed proprietary CE/IVD marked assays, including our HTG EdgeSeq DLBCL Cell of Origin Assay EU and HTG EdgeSeq ALKPlus Assay EU.

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Collaborative development revenue relates to services performed using our HTG EdgeSeq proprietary technology to develop, seek regulatory approval for and commercialize companion diagnostic assays for biopharmaceutical drug candidates and corresponding therapeutics. Collaborative development services revenue generated to date has primarily related to three statements of work entered into under our Governing Agreement with QML. In November 2019, we terminated the Governing Agreement, effective immediately, as a result of QML’s material breach of the Governing Agreement, including QML’s failure to develop an IVD version of its GeneReader. Our termination of the Governing Agreement did not terminate active statements of work under the Governing Agreement. On future agreements, we may choose to develop companion diagnostic products independently or with a collaboration partner.

Our business currently reflects a laboratory services and collaborative development services-oriented revenue model. However, we anticipate that this will be a catalyst toward an emerging product-based strategy in the long-term as additions to our diagnostic panel menu are expected to increase the demand for our instrument and consumables products in individual laboratories and customer locations.

We have incurred significant losses since our inception, and we have never been profitable. We incurred net losses of $19.3 million and $16.5 million for the years ended December 31, 2019 and 2018, respectively, and had an accumulated deficit of $170.3 million as of December 31, 2019. As of December 31, 2019, we had available cash and cash equivalents totaling approximately $7.6 million, investments in short-term available-for-sale securities totaling $25.4 million and had current liabilities of approximately $8.9 million and long-term liabilities of approximately $12.3 million, primarily attributable to our MidCap Term Loan and NuvoGen obligations. We believe that our existing resources will be sufficient to fund our planned operations for at least the next 12 months from the issuance of these consolidated financial statements included elsewhere in this report. However, we cannot provide assurances that our plans will not change or that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate.

Recent Developments

In January 2020, we received a European patent grant notification for our methods for subtyping diffuse large B-cell lymphoma, effective October 2019. We were previously granted a patent for this technology in the United States in 2018. We also appeared in two significant peer-reviewed publications, Cell and Nature. The total number of publications referencing our HTG EdgeSeq technology, including these peer-reviewed publications is now over 140 as of December 31, 2019.

From January 1, 2020 through March 15, 2020, we sold 4,399,062 shares of our common stock under the 2019 ATM Offering (see Note 14 with Cantor Fitzgerald at then-market prices for total gross proceeds of approximately $2.6 million. After deferred offering costs and sales commissions owed in connection with the 2019 ATM Offering, our aggregate net proceeds through March 15, 2020 were approximately $2.5 million.

In February 2020, we entered into an Exchange and Purchase Agreement with certain accredited investors (the “Investors”) pursuant to which we agreed to (i) issue to the Investors an aggregate of 41,100 shares of its newly designated Series A Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred”), in exchange for the Investors surrendering for cancellation an aggregate of 4,110,000 shares of its common stock (the “Exchange”) and (ii) sell and issue to the Investors an aggregate of 10,170 shares of Series A Preferred for an aggregate purchase price of $600,030, or $59.00 per share (the “Private Placement”), both of which were completed prior to the end of February 2020.

In February 2020, we amended our MidCap Term Loan and MidCap Revolving Loan agreements to (i) extend the interest only payments on the term loan advances by an additional 11 months, with principal on each term loan advance payable in 25 equal monthly installments beginning March 1, 2021 until paid in full on March 1, 2023, with the ability to further extend the interest-only period by an additional four months if we achieve a stated revenue milestone for the 12-month period ending on December 31, 2020; (ii) permit the use of the $3.3 million of escrowed funds previously deposited by us for repayment of the QNAH Convertible Note, subject to certain limitations; and (iii) to include a grant of a security interest in our intellectual property, effective as of the date of the amendments.

In March 2020, we entered into a purchase agreement ("LP Purchase Agreement") with Lincoln Park Capital Fund, LLC ("Lincoln Park") pursuant to which, upon the terms and subject to the conditions and limitations set forth therein, we have the right to sell to Lincoln Park up to $20,000,000 of shares of our common stock (“Purchase Shares”) from time to time over the 36-month term of the LP Purchase Agreement. The purchase price of the Purchase Shares will be based on recent closing prices of our common stock at the time of sale. We issued Lincoln Park an aggregate of 615,384 shares of our common stock as consideration for their purchase commitment pursuant to the LP Purchase Agreement.

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Factors Affecting our Performance

We believe that our future results of operations are dependent on several additional factors discussed below. While each of these areas present significant opportunities for us, they also pose significant risks and challenges that we must successfully address. See the section entitled “Risk Factors” for further discussion of these risks.

Biopharmaceutical Biomarker and Companion Diagnostic Solutions

Biopharmaceutical companies are continually working to improve the efficacy of their drug development process and the safety and efficacy of their drugs. We believe that our technology can support these initiatives by providing a seamless solution from biomarker discovery to a commercialized companion diagnostic test that can be used to assist clinicians in confidently prescribing these drugs to their patients. Our products and service solutions allow us to partner with our biopharmaceutical company customers to identify molecular biomarkers that can help determine which patients are most likely to benefit from a particular drug, validate these biomarkers in clinical trials and partner to commercialize the validated CDx assay. Customers can access our technology by purchasing our platform and assays for their internal use or by engaging us to perform certain services, including molecular profiling of respective cohorts in our VERI/O laboratory and development of custom RUO panels to support early stage clinical programs, IUO assays for clinical trials or companion diagnostic assays for approved drugs. Our product and service solutions have provided us with a growing number of early stage biomarker discovery programs and new opportunities to collaborate with biopharmaceutical companies in their drug development programs. Our business model is structured to allow us to capture revenue at each stage of the drug development lifecycle with the highest value in the form of a drug linked companion diagnostic as the ultimate objective.

Customer Adoption of HTG Technology

Today we believe the primary measures of adoption for our technology are the number of active programs in our biopharmaceutical company customer pipeline, the number of total active customers and revenue growth relating to new and existing customers. In the future, we expect increased sales of our products and services as we add new proprietary panels to our product menu and as additional European customers adopt our existing assays or custom assays for use in clinical diagnostic testing. While our current customer mix is dominated by biopharmaceutical company customers, we expect to see growth in clinical diagnostic labs as we commercialize companion diagnostic assays from the collaborative development services programs and as biomarker strategies are validated through our partnerships with key opinion leaders in Europe.

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

A key element of increasing adoption of our technology is our assay and panel menu available for use by our customers on the HTG EdgeSeq. To sell additional instruments, grow our installed base and drive larger consumable annuities we must develop and commercialize new assays and add to the utility of existing panels by expanding applications on our REVEAL software. Our arrangements with biopharmaceutical companies are expected to generate new menu items in addition to our diagnostic development strategies in immuno-oncology and next-generation pathology. We will remain focused on high quality instrument placements and consumable pull through as the primary indicators of future commercial adoption and success in our business.

Timing and effectiveness of research and development expenses

Our spending on collaboration-based research and development may vary substantially from period to period due to the nature and timing of biopharmaceutical company drug development processes and the development effort involved in reaching key milestones under our companion diagnostic development agreements. Costs from our collaborative development services programs, including but not limited to the quantity of HTG EdgeSeq assay kits and instruments, third-party sequencing equipment and third-party or internal labor required to complete development milestones, all of which are expensed to research and development expense in our consolidated statements of operations, can vary significantly from one development stage to the next. Expenses associated with our ongoing proprietary product research and development efforts are carefully managed and are standardized under our stage-gate-based new product development methodology. Program progress and priorities are assessed by time, quality and adherence to budgetary metrics at each phase of the product development.

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Potential Impact of the COVID-19 Pandemic

          Significant uncertainty remains as to the potential impact of the COVID-19 pandemic on our operations, and on the global economy as a whole. However, we believe it is likely that the COVID-19 pandemic will have a negative impact on our product and product-related services revenue and collaborative development services revenue in 2020. We believe this negative impact will be primarily demand-side driven as our customers experience disruptions in their own businesses from the pandemic. However, it is possible that the COVID-19 pandemic will also impact our workforce, supply chains or distribution networks or otherwise impact our ability to conduct sample processing services and custom assay development services and our ability to provide collaborative development services for companion diagnostic development programs.  

Financial Operations Overview and Consolidated Results of Operations

Comparison of the Years Ended December 31, 2019 and 2018

Revenue

We generate revenue from two primary sources: product and product-related services revenue from the sale of RUO and CE/IVD marked profiling products, sample processing services and custom assay development services to biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for biopharmaceutical companies under our companion diagnostic development programs.  

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

Collaborative development services revenue generated to date has primarily related to three statements of work entered into under our Governing Agreement with QML. Under these agreements, we and QML combined our technological and commercial strengths to offer biopharmaceutical companies a complete NGS-based solution for the development, manufacture and commercialization of companion diagnostic assays in support of and in conjunction with, biopharmaceutical companies’ drug development programs.

Total revenue decreased by 11% to $19.2 million for the year ended December 31, 2019 compared with total revenue of $21.5 million for the year ended December 31, 2018. The decrease in total revenue was driven by the decrease of revenue generated from collaborative development services relating to our Governing Agreement, as existing programs reached biopharmaceutical company partner decision points and no new collaborative development programs were entered into in 2019. This decrease was substantially offset by increased product and product-related services profiling revenue compared with 2018, driven by the demand for our RUO service offerings as a result of the expansion of our RUO assay menu and the continued strengthening of relationships with key biopharmaceutical company customers.

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Product and product-related services revenue

Product and product-related services revenue, which includes biomarker profiling revenue generated through the sale of our HTG EdgeSeq instruments and consumables and from services performed for customers in our VERI/O laboratory using our proprietary RUO technology, increased $5.5 million to $14.6 million for the year ended December 31, 2019 compared with $9.1 million for the year ended December 31, 2018, and was comprised of the following:

Product revenue generated from the sale of our HTG EdgeSeq instruments and RUO and CE/IVD assay kits increased 92% to $4.4 million for the year ended December 31, 2019 compared with $2.3 million for the year ended December 31, 2018, and represented 23% and 11% of our total revenue for the years ended December 31, 2019 and 2018, respectively. The increase in product revenue in 2019 compared with 2018 is attributable to increased sale of our instruments and consumables as a result of the expansion of the menu of profiling assays that is available for purchase by the increasing number of customers who have adopted our technology in the United States and Europe.

Service revenue, consisting of sample processing using our HTG EdgeSeq instruments and consumables in our VERI/O laboratory and custom RUO assay development, increased by $3.4 million to $10.2 million for the year ended December 31, 2019 compared with $6.8 million for the year ended December 31, 2018, and represented 53% and 32% of our total revenue for the years ended December 31, 2019 and 2018, respectively. The increase in service revenue for the year ended December 31, 2019 compared with 2018 primarily reflects an increase in the development of custom RUO panels which are expected to generate future sample processing, collaborative development services or RUO consumables revenue.

Collaborative development services revenue

Collaborative development services revenue includes services performed on biopharmaceutical company companion diagnostic development programs using our HTG EdgeSeq proprietary technology to develop, validate in clinical trials, seek regulatory approvals for and commercialize CDx assays for biopharmaceutical company therapeutics. Collaborative development services revenue, consisting of precision diagnostic program services performed for biopharmaceutical companies pursuant to our Governing Agreement with QML, decreased $7.8 million to approximately $4.6 million for the year ended December 31, 2019 compared with approximately $12.4 million for the year ended December 31, 2018, and represented 24% and 58% of our total revenue for the years ended December 31, 2019 and 2018, respectively. Collaborative development services revenue for the year ended December 31, 2019 included approximately $3.2 million of monthly development fees and $1.4 million of profit-sharing payments. Collaborative development services revenue for the year ended December 31, 2018 included approximately $10.2 million of monthly development fees and $2.2 million of profit-sharing payments. This variability is reflective of the number of active programs in each of these periods, the amount and timing of work to be performed under each program, the timing and number of development deliverables and the timing and amount of any profit-sharing payments under these agreements. Given these factors, we expect there to continue to be significant variability in the timing and amount of collaborative development services revenue recognized from one fiscal period to the next. No new collaborative development services programs were entered into in 2019 and our existing programs are awaiting additional activity based on customer decision points. As a result, we currently do not anticipate significant revenue from collaborative development services programs in 2020.  

Cost of product and product-related services revenue

Cost of product and product-related services revenue includes product-related and services-related costs. Product-related costs include the aggregate costs incurred in manufacturing, delivering, installing and servicing instruments and consumables. The components of our product-related costs of revenue include consumables and lab supplies, subcomponent and servicing costs, manufacturing costs incurred internally (which include direct labor costs), and equipment and infrastructure expenses associated with the manufacturing and distribution of our products. Due to the fixed nature of certain of these expenses, such as overhead, equipment and infrastructure, associated with our regulated industry and our expectations for further growth in customer demand, we expect our cost of product and product-related services revenue as a percentage to decrease over time as we increase product and product-related services revenue, further absorbing these fixed costs.

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Cost of product and product-related services revenue increased by 75% to $8.9 million for the year ended December 31, 2019 compared with $5.1 million for the year ended December 31, 2018. This overall increase reflects the increase in product and product‑related services revenue in 2019 compared with 2018. The increase in cost of product and product-related services revenue as a percentage of product and product-related services revenue is primarily the result of low margin subcontracted laboratory services relating to two large ongoing biopharmaceutical company customer programs for which the related revenue is in product-related services revenue for the year ended December 31, 2019. While we do not anticipate recurrence of these significant levels of subcontracted laboratory services in future periods, we expect we might need to contract these services for biopharmaceutical company programs from time to time in support of the overall development of custom assays.

Selling, general and administrative expenses

Selling, general and administrative expenses consist primarily of personnel costs for our sales and marketing, regulatory, legal, executive management and finance and accounting functions. The expenses also include third-party professional and consulting fees incurred by these functions, promotional expenses and facility and overhead costs for our administrative offices. Selling, general and administrative expenses decreased by $1.3 million to $18.7 million for the year ended December 31, 2019 compared with $20.0 million for the year ended December 31, 2018. The decrease in our selling, general and administrative expenses are primarily due to executive officers’ restricted stock grants that resulted in approximately $1.0 million of additional non-cash, stock-based compensation expense for the year ended December 31, 2018.

Research and development expenses

Research and development expenses represent amounts incurred to perform collaborative development services, costs to develop new proprietary panels and corresponding assays and costs to continue to develop and improve our HTG EdgeSeq platform. These expenses include payroll and related expenses, consulting expenses, laboratory supplies, facilities and equipment. Research and development costs are expensed as incurred. Research and development expenses decreased by $2.0 million to $10.6 million for the year ended December 31, 2019 compared with $12.6 million for the year ended December 31, 2018. This decrease is primarily due to the decrease in collaborative development costs associated with biopharmaceutical customer companion diagnostic development programs, which costs are included in research and development expense in our consolidated statements of operations as the contracts are accounted for under the FASB’s guidance for collaborative arrangements. Research and development costs relating to our collaborative development services revenue were approximately $2.8 million for the year ended December 31, 2019 compared with $8.0 million for the year ended December 31, 2018. We expect research and development costs to continue to increase in 2020 as we progress toward key milestones in the development of our whole transcriptome assay being developed in our California laboratory and continue to build new applications to add to the utility of our existing proprietary panels.

Interest income (expense)

As of December 31, 2019, we had an obligation due to NuvoGen in the amount of $5.7 million under an asset purchase agreement, a MidCap Term Loan obligation of $6.9 million, net of discount and deferred financing costs and a $3.0 million convertible debt liability to QNAH. Interest expense and non-cash interest expense recognized for discount, deferred financing fee amortization and final fee premium amounts relating to these obligations increased to $1.0 million for the year ended December 31, 2019 as compared with $0.9 million for the year ended December 31, 2018. Interest income included in interest income (expense) decreased by $92,368 to $623,355 for the year ended December 31, 2019 as compared with $715,723 for the year ended December 31, 2018 primarily as a result of available-for-sale securities investments made with the net proceeds from our January 2018 underwritten public offering with Leerink Partners LLC and Cantor Fitzgerald & Co. (“Cantor”) used to fund operations throughout 2019.

Cash Flows for the Years Ended December 31, 2019 and 2018

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

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Operating Activities

Net cash used in operating activities for the year ended December 31, 2019 increased by $3.5 million to $16.7 million compared with $13.2 million for the year ended December 31, 2018. This increase for the year ended December 31, 2019 reflected (i) the net loss of $19.3 million and (ii) net non-cash items of $3.1 million, consisting primarily of stock-based compensation of $1.2 million and depreciation and amortization of $1.3 million.

Net cash used in operating activities for the year ended December 31, 2018 was $13.2 million and reflected (i) the net loss of $16.5 million and (ii) net non-cash items of $3.3 million, consisting primarily of stock-based compensation of $1.9 million and depreciation and amortization of $1.5 million.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2019 decreased by $19.7 million to $3.5 million compared with $23.2 million for the year ended December 31, 2018. Net cash used in investing activities for the year ended December 31, 2019 consisted primarily of purchases of available-for-sale securities of $34.6 million, partially offset by the maturity of $32.2 million of the available-for-sale securities and the purchase of $1.1 million of laboratory equipment for our California-based technology center and other fixed assets during the year.

Net cash used in investing activities for the year ended December 31, 2018 was $23.2 million and consisted primarily of purchases of available-for-sale securities of $54.0 million with proceeds received from our underwritten public offering in January 2018, partially offset by the maturity of $31.7 million of the available-for-sale securities and the purchase of $0.9 million of tooling used in manufacturing, furniture and equipment for our new applications laboratory in France and other fixed assets during the year.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2019 decreased by $18.7 million to $19.4 million compared with $38.1 million for the year ended December 31, 2018. This activity for the year ended December 31, 2019 consisted primarily of $20.8 million in net proceeds from our 2019 underwritten public and private offerings with Cantor and $1.3 million in payments on our NuvoGen obligation.

Net cash provided by financing activities for the year ended December 31, 2018 was $38.1 million and consisted primarily of $37.7 million in net proceeds from our underwritten public offering in January 2018, $6.6 million in net proceeds from our MidCap Term Loan in March 2018, and $0.6 million in net proceeds from an at-the-market offering of our common stock through our 2017 Controlled Equity Offering Sales Agreement with Cantor, partially offset by $6.0 million in payments on our Growth Term Loan balance and $1.0 million in payments on our NuvoGen obligation.

Liquidity and Capital Resources

Since our inception, our operations have primarily been financed through the issuance of our common stock, redeemable convertible preferred stock, the incurrence of debt and cash received from product sales, services revenue and other income. As of December 31, 2019, we had $33.0 million in cash, cash equivalents and investments in short-term available-for-sale securities, and $17.0 million of liabilities outstanding relating to our MidCap Term Loan, NuvoGen and QNAH Convertible Note obligations and our financing and operating leases.

In March 2018, we entered into the MidCap Term Loan and the Midcap Revolving Loan with MidCap Financial Trust, as agent. The MidCap Term Loan provides a secured term loan facility in an aggregate principal amount of up to $20.0 million. We borrowed the first advance of $7.0 million in March 2018. Under the terms of the MidCap Term Loan, the second advance of $13.0 million was to be available to us on or before September 30, 2019, subject to the Company’s satisfaction of certain conditions described in the MidCap Term Loan. As the Company did not satisfy these conditions, MidCap Tranche 2 was not made available to the Company for borrowing. All obligations under the Growth Term Loan were terminated and all outstanding amounts and fees due under the Growth Term Loan were repaid with proceeds from the MidCap Term Loan in March 2018. Amounts outstanding under the MidCap Term Loan bear interest at a floating rate equal to 7.25% per annum, plus the greater of (i) 1.25% or (ii) the one-month LIBOR. With the amendment of the MidCap Revolving Loan and the MidCap Term Loan in February 2020, principal on each term loan advance is payable in 25 equal monthly installments beginning March 1, 2021 until paid in full on March 1, 2023. If we achieve a stated revenue milestone for the 12-month period ending on December 31, 2020, the interest-only period will be further extended by an additional four months, with principal on each term loan advance then payable in 21 equal monthly installments beginning July 1, 2021 until paid in full on March 1, 2023. The proceeds remaining from the March 2018 MidCap Term Loan funding are expected to be used for working capital and general corporate purposes.

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LIBOR is currently scheduled to be phased out in 2021. Before LIBOR is phased out, we expect to modify the MidCap Credit Facility to replace LIBOR with a new reference rate, which has yet to be established. The consequences of these developments cannot be entirely predicted but might result in higher interest rates on our borrowings under the MidCap Credit Facility.

The MidCap Revolving Loan provides a secured revolving credit facility in an aggregate principal amount of up to $2.0 million. We may request an increase in the total commitments under the MidCap Revolving Loan by up to an additional $8.0 million, subject to agent and lender approval and the satisfaction of certain conditions. Availability of the revolving credit facility under the MidCap Revolving Loan will be based upon a borrowing base formula and periodic borrowing base certifications valuing certain of our accounts receivable and inventory, as reduced by certain reserves, if any. Though the MidCap Revolving Loan was made available upon our establishment of certain lockbox arrangements in June 2018, there were no amounts outstanding under the MidCap Revolving Loan as of December 31, 2019. The proceeds of any loans under the MidCap Revolving Loan may be used for working capital and general corporate purposes.

In September 2019, we completed an underwritten public offering in which we sold 29,298,537 shares of our common stock at a price of $0.65 per share, including 3,821,548 shares sold pursuant to the exercise in full of the underwriter’s option to purchase additional shares. The shares of common stock described above were offered pursuant to a Registration Statement on Form S-3 (File No. 333-229045) previously filed with the SEC and declared effective by the SEC on February 11, 2019, and a prospectus supplement thereafter. In addition, we concurrently entered into a securities purchase agreement with certain institutional accredited investors for the sale of 5,411,687 pre-funded warrants exercisable for an aggregate of 5,411,687 shares of common stock, at a purchase price of $0.64 per pre-funded warrant. The aggregate net proceeds from these offerings were approximately $20.8 million, after deducting the underwriting discounts and commissions and offering expenses.

In March 2020, we entered into a purchase agreement ("LP Purchase Agreement") with Lincoln Park Capital Fund, LLC ("Lincoln Park") pursuant to which, upon the terms and subject to the conditions and limitations set forth therein, we have the right to sell to Lincoln Park up to $20,000,000 of shares of our common stock (“Purchase Shares”) from time to time over the 36-month term of the LP Purchase Agreement. The purchase price of the Purchase Shares will be based on recent closing prices of our common stock at the time of sale. We issued Lincoln Park an aggregate of 615,384 shares of our common stock as consideration for their purchase commitment pursuant to the LP Purchase Agreement.

Funding Requirements

We have had recurring operating losses and negative cash flows from operations since our inception and have an accumulated deficit of approximately $170.3 million as of December 31, 2019. As of December 31, 2019, we had cash, cash equivalents and investments in short-term available-for-sale securities of approximately $33.0 million and had current liabilities of approximately $8.9 million. As of December 31, 2019, we also had $12.3 million in long-term liabilities primarily attributable to our MidCap Term Loan and NuvoGen obligations. We believe that our existing resources will be sufficient to fund our planned operations and expenditures for at least the next 12 months from the issuance of these consolidated financial statements. However, we cannot provide assurances that our plans will not change or that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate.

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

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

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Contractual Obligations

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

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements as defined by applicable SEC regulations.

Recent Accounting Pronouncements

For a summary of recent accounting pronouncements applicable to our consolidated financial statements, see “Note 2. Basis of Presentation and Summary of Significant Accounting Policies” in Part II, Item 8, Notes to Consolidated Financial Statements.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Items subject to estimates based on judgments include, but are not limited to: revenue recognition, fair value measurements, stock-based compensation expense, the value of our lease and warrant liabilities, the resolution of uncertain tax positions, income tax valuation allowances and reserves, recovery of long-lived assets and provisions for doubtful accounts, inventory obsolescence and inventory valuation. Actual results could differ from these estimates and such differences could affect the results of operations in future periods.

Revenue from Contracts with Customers

Revenue from contracts with customers is recognized when, or as, we satisfy our performance obligations by delivering the promised goods or service deliverables to our customers. A good or service deliverable is transferred to a customer when, or as, the customer obtains control of that good or service deliverable. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring our progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that we determine the customer obtains control over the promised good or service deliverable. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for those promised goods or services (i.e., the “transaction price”). In determining the transaction price, we consider multiple factors, including the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. In determining when to include variable consideration in the transaction price, we consider the range of possible outcomes, the predictive value of its past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgment and actions of third parties.

For contracts where the period between when we transfer a promised good or service to the customer and when the customer pays is one year or less, we have elected the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component.

We have made a policy election to exclude from the measurement of the transaction price all taxes assessed by a government authority that are both imposed on and concurrent with a specific revenue producing transaction and collected from a customer. Such taxes may include but are not limited to sales, use, value added and certain excise taxes.

Product and Product-related Services Revenue

Sale of instruments and consumables

The delivery of each instrument and related installation and calibration are considered to be a single performance obligation, as the HTG EdgeSeq instrument must be professionally installed and calibrated prior to use. Instrument product revenue is generally recognized upon installation and calibration of the instrument by field service engineers, which represents the point at which the customer has the ability to use the instrument and has accepted the asset. Installation generally occurs within one month of instrument shipment.

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The delivery of each consumable is a separate performance obligation. Consumables revenue is recognized upon transfer of control, which represents the point when the customer has legal title and the significant risks of ownership of the asset. Our standard terms and conditions provide that no right of return exists for instruments and consumables, unless replacement is necessary due to delivery of defective or damaged product. Customer payment terms vary but are typically between 30 and 90 days of revenue being earned from shipment or delivery, as applicable.

Shipping and handling fees charged to customers for instruments shipped are included in the accompanying consolidated statements of operations as part of product and product-related services revenue. Shipping and handling costs for products shipped to customers are included in the accompanying consolidated statements of operations as part of cost of product and product-related services revenue.

For sales of consumables in the United States, standard delivery terms are FOB shipping point, unless otherwise specified in the customer contract, reflecting transfer of control to the customer upon shipment. Standard delivery terms for sales to customers outside of the United States are FOB delivery point, unless otherwise specified in the customer contract. We have elected the practical expedient to account for shipping and handling as activities to fulfill the promise to transfer the consumables.

We provide instruments to certain customers under reagent rental agreements. Under these agreements, an instrument is installed in the customer’s facility without a fee and the customer agrees to purchase consumable products at a stated price over the term of the agreement; in some instances, the agreements do not contain a minimum purchase requirement. Terms range from several months to multiple years and may automatically renew in several month or multiple year increments unless either party notifies the other in advance that the agreement will not renew. We measure progress toward complete satisfaction of this performance obligation to provide the instrument and deliver the consumables using an output method based on the number of consumables delivered in relation to the total consumables to be provided under the reagent rental agreement. This is considered to be representative of the delivery of outputs under the arrangement and the best measure of progress because the customer benefits from the instrument only in conjunction with the consumables. We expect to recover the cost of the instrument under the agreement through the fees charged for consumables, to the extent sold, over the term of the agreement.

In reagent rental agreements, we retain title to the instrument and title is transferred to the customer at no additional charge at the conclusion of the initial arrangement. The cost of the instrument is amortized on a straight-line basis over the term of the arrangement, unless there is no minimum consumable product purchase, in which case the instrument would be expensed as cost of product and product-related services revenue upon installation. Cost to maintain the instrument while we hold title is charged to selling, general and administrative expense as incurred.

Service revenue

Sample Processing Services

We also provide sample preparation and processing services and molecular profiling of retrospective cohorts for its customers through its VERI/O laboratory, whereby the customer provides samples to be processed using HTG EdgeSeq technology specified in the order. Customers are charged a per sample fee for sample processing services which is recognized as revenue upon delivery of a data file to the customer showing the results of testing and completing delivery of the agreed upon service. This is when the customer can use and benefit from the results of testing and we have the present right to payment.

Custom RUO Assay Development

We enter into custom RUO assay design agreements that may generate up-front fees and subsequent payments that might be earned upon completion of design process phases. Progress is measured toward complete satisfaction of the performance obligation to perform custom RUO assay design using an output method based on the costs incurred to date compared to total expected costs, as this is representative of the delivery of outputs under the arrangements and the best measure of progress. However, because in most instances the assay development fees are contingent upon completion of each phase of the design project and the decision of the customer to proceed to the next phase, the amount to be included in the transaction price and recognized as revenue is limited to that which the customer is contractually obligated to pay upon completion of that phase, which is when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Changes in estimates of total expected costs are accounted for prospectively as a change in estimate. From period to period, custom RUO assay design service revenue can fluctuate substantially based on the completion of design-related phases.

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Collaborative Development Services

We follow ASC 606, Revenue from Contracts with Customers and ASC 808, Collaborative Arrangements to determine the appropriate recognition of revenue under our collaborative research, development and commercialization agreements that contain multiple elements. For the years ended December 31, 2019 and 2018, collaborative development services revenue was generated from our Governing Agreement with QML. We have determined that SOW One, SOW Two and SOW Three under the Governing Agreement are collaborative arrangements and that QML meets the definition of a customer under ASC 606. Additionally, each SOW is a separate contract with a single performance obligation to provide development services. Under each SOW, QML pays a monthly fee for development work performed by us and our subcontractors. The monthly fee is based on the employee and materials costs incurred during the month, which is subject to significant variability from period to period and unknown until the costs are incurred. Therefore, the monthly fee, which is based on use of hours and costs as a measure of progress, is included in the transaction price and recognized as revenue over time when the costs are incurred and the monthly fee is billed to QML. As we have the right to consideration from the customer in an amount that corresponds directly to the value to the customer of our performance completed to date, we recognize revenue in the amount to which we have the right to invoice. It is at this time that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. We also share any net profits resulting from performance of the development work with QML as determined pursuant to the Governing Agreement. Such profit-sharing payment(s) is deemed to be variable consideration using the expected value method and is included in the transaction price upon completion of the respective SOW deliverables, acceptance of corresponding deliverables, and the mutual agreement by both parties on the calculation of net profit, which is when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur.

Because each SOW has an expected duration of one year or less, we have elected the practical expedient in ASC 606-10-50-14(a) to not disclose information about its remaining performance obligations for each SOW.

Fair Value Measurements

We establish the fair value of all of our financial assets and liabilities, which are recognized and disclosed at fair value in the consolidated financial statements, using the price that would be received to sell an asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy is used to measure fair value. The three levels of the fair value hierarchy are as follows:  

Level 1 – Quoted prices in active markets for identical assets and liabilities.

Level 2 – Pricing inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable and include situations where there is little, if any, market activity for the investment.

Our portfolio of securities comprises U.S. Treasuries and high credit quality corporate debt securities classified as available-for-sale securities.

Inventory Valuation

Inventory consists of raw materials and finished goods which are stated at the lower of cost (first-in, first-out) or net realizable value. We reserve or write down inventory for estimated obsolescence, inventory in excess of reasonably expected near term sales or unmarketable inventory, in an amount equal to the difference between the cost of inventory and the estimated market value, based upon assumption about future demand and market conditions. If actual market conditions are less favorable than those projected, additional inventory adjustments 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.

Leases

Effective January 1, 2019, we account for our leases under ASC 842, Leases (“ASC 842”). Under this guidance, arrangements meeting the definition of a lease are classified as operating or financing leases and are recorded on the consolidated balance sheets as both a right-of-use asset and lease liability, calculated by discounting fixed lease payments over the lease term at the rate implicit in the lease or our incremental borrowing rate. Lease liabilities are increased by interest and reduced by payments each period, and the right-of-use asset is amortized over the lease term. For operating leases, interest on the lease liability and the amortization of the right-of-use asset result in straight-line rent expense over the lease term. For financing leases, interest on the lease liability and the amortization of the right-of-use asset results in front-loaded expense over the lease term. Variable lease expenses are recorded to rent expense as incurred.

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Certain leasehold improvements constructed by the landlord of our Tucson, AZ facilities as an incentive for us to extend our leases are included in leasehold improvements in the consolidated balance sheets as of December 31, 2018. The total cost of the improvements constructed by the landlord of $710,000 was capitalized when construction was completed in February 2016 and is being amortized over the remaining term of the lease agreement. The incentive of $710,000 was also recognized as deferred rent and was being amortized over the lease term as a reduction of lease expense. As of December 31, 2018, the remaining unamortized incentive of $295,833 was recognized as deferred rent within other current liabilities and other liabilities, in accordance with ASC Topic 840, Leases (“ASC 840”). Upon implementation of ASC 842, the $295,833 remaining unamortized incentive of was recognized as an offset to operating lease right-of-use asset in the consolidated balance sheets.

In calculating the right-of-use asset and lease liability, we have elected to combine lease and non-lease components for all classes of assets currently under lease, including facilities and computer equipment. We have also excluded short-term leases having initial terms of 12 months or less from the new guidance as an accounting policy election and recognizes rent expense on a straight-line basis over the lease term for these leases.

Stock-Based Compensation

We recognize compensation costs related to stock-based payments to employees, including grants under our equity incentive plans of stock options and restricted stock units (“RSUs”) and stock purchase rights granted under our ESPP, based on the estimated fair value of the awards on the date of grant. The fair value of RSUs is based on the quoted market price of our common stock on the date of grant. We do not estimate the number of awards expected to be forfeited but instead we account for them as they occur. The fair value of ESPP rights and stock options granted pursuant to our equity incentive plans is estimated on the date of grant using the Black-Scholes option pricing model. The determination of the fair value using the Black-Scholes option pricing model is affected by the fair value of our common stock and several assumptions, including volatility, expected term, risk-free interest rate and dividend yield. Generally, these assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. These estimates involve inherent uncertainties. Changes to the assumptions that we have used in the Black-Sholes option pricing model could significantly impact the compensation expense that has been recognized in our consolidated statements of operations. If we had made different assumptions, our stock-based compensation expense, net loss and net loss per share of common stock could have been significantly different.

Foreign Currency Translation and Foreign Currency Transactions

We have assets and liabilities, including accounts receivable and accounts payable, which are denominated in currencies other than our functional currency. These balance sheet items are subject to re-measurement, the impact of which is recorded in selling, general and administrative expense within the consolidated statements of operations.

Adjustments resulting from translating foreign functional currency financial statements of our wholly owned subsidiary into U.S. Dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive loss in the accompanying consolidated statements of stockholder’s equity (deficit).

Income Taxes

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts and tax base of assets and liabilities using enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established against net deferred tax assets for the uncertainty it presents of our ability to use the net deferred tax assets, in this case, primarily carryforwards of net operating tax losses and research and development tax credits. In assessing the realizability of net deferred tax assets we have assessed the likelihood that net deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not “more likely than not” or there is an insufficient history of operating profits, a valuation allowance is established. We record the valuation allowance in the period we determine that it is more likely than not that net deferred tax assets will not be realized. For the years ended December 31, 2019 and 2018, we have provided a full valuation allowance for all net deferred tax assets due to their current realization being considered remote. Uncertain tax positions taken or expected to be taken in a tax return are accounted for using the more likely than not threshold for financial statement recognition and measurement. The Tax Act, which was signed into law on December 22, 2017, significantly revised the IRC. For further information as to its impact on our financial statements see “Note 16. Income Taxes” in Part II, Item 8, Notes to Financial Statements.

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Emerging Growth Company Status

We are an “emerging growth company” as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

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

Item 8. Consolidated Financial Statements and Supplementary Data.

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INDEX TO FINANCIAL STATEMENTS

F-1

Report of Independent Registered Public Accounting Firm

Stockholders and Board of Directors

HTG Molecular Diagnostics, Inc.

Tucson, Arizona

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of HTG Molecular Diagnostics, Inc. (the “Company”) and subsidiary as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive loss, changes in stockholders’ equity (deficit), and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiary at December 31, 2019 and 2018, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Change in Accounting Method Related to Leases

As discussed in Notes 2 and 11 to the consolidated financial statements, the Company has changed its method of accounting for leases during the year ended December 31, 2019 due to the adoption of Accounting Standards Codification (“ASC”) 842, Leases.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ BDO USA, LLP

We have served as the Company's auditor since 2014.

Los Angeles, California

March 25, 2020

F-2

HTG Molecular Diagnostics, Inc.

Consolidated Balance Sheets

The accompanying notes are an integral part of these consolidated financial statements.

F-3

HTG Molecular Diagnostics, Inc.

Consolidated Statements of Operations

The accompanying notes are an integral part of these consolidated financial statements.

F-4

HTG Molecular Diagnostics, Inc.

Consolidated Statements of Comprehensive Loss

The accompanying notes are an integral part of these consolidated financial statements.

F-5

HTG Molecular Diagnostics, Inc.

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)