Natera, Inc. - Quarter Report: 2016 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-37478

NATERA, INC.

(Exact Name of Registrant as Specified in Its Charter)


Delaware	01‑0894487
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)


201 Industrial Road, Suite 410 San Carlos, CA	94070
(Address of Principal Executive Offices)	(Zip Code)

(650) 249‑9090

(Registrant’s Telephone Number, Including Area Code)

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

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

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


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

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

As of October 31, 2016, the number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, was 52,382,613.

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Natera, Inc.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016

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		Page

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Part I — Financial Information
	Item 1. Financial Statements (unaudited)	5
	Condensed Consolidated Balance Sheets at September 30, 2016 and December 31, 2015	5
	Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months Ended September 30, 2016 and 2015	6
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015	7
	Notes to Unaudited Interim Condensed Consolidated Financial Statements	8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
	Item 4. Controls and Procedures	41

Part II — Other Information
	Item 1. Legal Proceedings	41
	Item 1A. Risk Factors	43
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	78
	Item 3. Defaults Upon Senior Securities	78
	Item 4. Mine Safety Disclosures	78
	Item 5. Other Information	78
	Item 6. Exhibits	78
	Signatures	79

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements. The forward-looking statements are contained principally in the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but are also contained elsewhere in this report. Forward-looking statements include information concerning our future results of operations and financial position, strategy and plans, and our expectations for future operations. Forward-looking statements include all statements that are not historical facts and, in some cases, can be identified by terms such as "believe," "may," "will," "estimate," "continue," "anticipate," "design," "intend," "expect," "could," "plan," "potential," "predict," "seek," "should," "would" or the negative version of these words and similar expressions.

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements, including those described in "Risk Factors" and elsewhere in this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our beliefs and assumptions only as of the date of this report. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. You should read this report completely and with the understanding that our actual future results may be materially different from what we expect.

These forward-looking statements include, but are not limited to, statements concerning the following:

our expectation that, for the foreseeable future, a significant portion of our revenues will be derived from sales of Panorama;

our ability to increase demand for Panorama, expand geographically, and obtain favorable coverage and reimbursement determinations from third-party payers;

our reliance on our partners to market and offer Panorama in the United States and in international markets;

our expectation that Panorama will be adopted for broader use in average-risk pregnancies and for the screening of microdeletions and that third-party payer reimbursement will be available for these applications;

the scope of protection we establish and maintain for, and developments or disputes concerning, our intellectual property or other proprietary rights;

our ability to successfully develop additional revenue opportunities and expand our product offerings to include new tests, including in the field of cancer diagnostics;

competition in the markets we serve;

our expectations of the reliability, accuracy, and performance of Panorama, as well as expectations of the benefits to patients, providers, and payers of Panorama;

our reliance on collaborators such as medical institutions, contract laboratories, laboratory partners, and other third parties;

our ability to operate our laboratory facility and meet expected demand;

our reliance on a limited number of suppliers, including sole source suppliers, which may impact the availability of replacement laboratory instruments and materials;

our expectations of the rate of adoption of Panorama and of any of our future tests by laboratories, clinics, clinicians, payers, and patients;

our ability to publish clinical data in peer-reviewed medical publications regarding Panorama and any of our future tests;

our ability to successfully implement our cloud-based distribution model;

our estimates regarding our costs and risks associated with our international operations and international expansion;

our ability to retain and recruit key personnel;

our reliance on our direct sales efforts;

our expectations regarding acquisitions and strategic operations;

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our ability to fund our working capital requirements;

our compliance with federal, state, and foreign regulatory requirements;

the factors that may impact our financial results; and

anticipated trends and challenges in our business and the markets in which we operate.

Any forward-looking statement made by us in this report speaks only as of the date on which it is made. Except as required by law, we disclaim any obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

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PART I – FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

Natera, Inc.

Condensed Consolidated Balance Sheets

(In thousands)


	September 30,		December 31,
	2016		2015
Assets		(unaudited)		(Note 2)
Current assets:
Cash and cash equivalents	$	25,322	$	28,947
Restricted cash, current portion		1,188		901
Short-term investments		157,717		201,586
Accounts receivable, net of allowance of $1,322 in 2016 and $971 in 2015		9,408		5,862
Inventory		9,249		8,093
Prepaid expenses and other current assets		9,394		5,337
Total current assets		212,278		250,726
Property and equipment, net		25,616		12,710
Restricted cash, long term portion		342		683
Other assets		4,149		1,121
Total assets	$	242,385	$	265,240
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	8,811	$	7,332
Accrued compensation		10,214		8,552
Other accrued liabilities		23,347		18,708
Deferred revenue		576		144
Short-term debt financing		49,473		42,090
Warrants		3,558		3,649
Total current liabilities		95,979		80,475

Deferred rent, net of current portion		6,092		—
Total liabilities		102,071		80,475

Commitments and contingencies (Note 6)
Stockholders’ equity:
Common stock		6		5
Additional paid in capital		447,915		436,259
Accumulated deficit		(307,941)		(250,083)
Accumulated other comprehensive income (loss)		334		(1,416)
Total stockholders’ equity		140,314		184,765
Total liabilities and stockholders’ equity	$	242,385	$	265,240

See accompanying notes to the unaudited interim condensed consolidated financial statements.

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Natera, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

(In thousands, except per share data)


	Three months ended				Nine months ended
	September 30,				September 30,
	2016		2015		2016		2015
Revenues
Product revenues	$	53,090	$	44,423	$	165,457	$	135,841
Other revenues		799		498		2,318		1,603
Total revenues		53,889		44,921		167,775		137,444
Cost and expenses
Cost of product revenues		34,261		30,456		97,574		81,032
Research and development		11,345		7,336		30,403		19,707
Selling, general and administrative		34,938		27,870		98,573		79,195
Total cost and expenses		80,544		65,662		226,550		179,934
Loss from operations		(26,655)		(20,741)		(58,775)		(42,490)
Interest expense		(146)		(1,177)		(383)		(3,391)
Interest benefit (expense) from changes in the fair value of long term debt		—		1,810		—		(312)
Interest and other income (expense), net		887		2,478		1,403		(1,122)
Loss before income taxes		(25,914)		(17,630)		(57,755)		(47,315)
Income tax expense		(103)		—		(103)		—
Net loss	$	(26,017)	$	(17,630)	$	(57,858)	$	(47,315)
Unrealized (loss) gain on available-for-sale securities, net of tax		(609)		36		1,750		36
Comprehensive loss	$	(26,626)	$	(17,594)	$	(56,108)	$	(47,279)

Basic and diluted net loss per share	$	(0.50)	$	(0.39)	$	(1.13)	$	(2.53)

Weighted-average number of shares used in computing basic and diluted net loss per share		52,012		44,944		51,301		18,721

See accompanying notes to the unaudited interim condensed consolidated financial statements.

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Natera, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(In thousands)


	Nine months ended
	September 30,
	2016		2015
Operating activities
Net loss	$	(57,858)	$	(47,315)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		4,177		4,363
Amortization of premium on investment securities		1,145		—
Amortization of debt discount		—		28
Gain on sales of property and equipment		—		(2)
Impairment of assets		407		1,258
Non-cash interest accrual		383		—
Gain on investments		(192)		—
Stock-based compensation		7,965		4,906
(Gain) loss from changes in fair value of warrants		(91)		1,509
Loss from change in fair value of long term debt		—		312
Provision for doubtful accounts		354		279
Changes in operating assets and liabilities:
Accounts receivable		(3,900)		(157)
Inventory		(1,156)		(1,863)
Prepaid expenses and other current assets		(4,057)		(3,668)
Restricted cash		54		(303)
Other assets		(3,028)		(573)
Accounts payable		1,653		102
Accrued compensation		1,662		1,647
Other accrued liabilities		1,552		6,341
Deferred revenue		432		(7)
Deferred rent		6,092		—
Net cash used in operating activities		(44,406)		(33,143)

Investing activities
Purchases of investments		(48,519)		(26,353)
Proceeds from sale of investments		59,185		—
Proceeds from maturity of investments		34,000		—
Purchases of property and equipment, net		(14,577)		(6,452)
Net cash provided by (used in) investing activities		30,089		(32,805)

Financing activities
Proceeds from initial public offering, net of issuance costs		—		180,628
Proceeds from exercise of stock options		2,722		—
Proceeds from issuance of common stock under employee stock purchase plan		970		—
Borrowings under credit facility		8,000		—
Repayment under credit facility		(1,000)		—
Costs paid for loan		—		(6)
Repayments of equipment financing		—		(5,850)
Proceeds from collection of officer receivable		—		192
Net cash provided by financing activities		10,692		174,964

Net (decrease) increase in cash		(3,625)		109,016
Cash at beginning of period		28,947		87,176
Cash at end of period	$	25,322	$	196,192

See accompanying notes to the unaudited interim condensed consolidated financial statements.

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Natera, Inc.

Notes to Unaudited Interim Condensed Consolidated Financial Statements

1. Description of Business

Natera, Inc. (the "Company") was formed in the state of California as Gene Security Network, LLC in November 2003 and incorporated in the state of Delaware in January 2007. The Company’s mission is to change the management of genetic disease worldwide. The Company operates a laboratory certified under the Clinical Laboratory Improvement Amendments ("CLIA") providing a host of preconception and prenatal genetic testing services. The Company operates in one segment and has a subsidiary that operates in the state of Texas.

The Company's product offerings include its Panorama Non-Invasive Prenatal Test ("NIPT") that screens for chromosomal abnormalities of a fetus typically with a blood draw from the mother; Horizon Carrier Screening ("Horizon") to determine carrier status for a large number of severe genetic diseases that could be passed on to the carrier’s children; Spectrum Pre-implantation Genetic Screening ("PGS") and Spectrum Pre-implantation Genetic Diagnosis ("PGD") to analyze chromosomal anomalies or inherited genetic conditions during an in vitro fertilization ("IVF") cycle to select embryos with the highest probability of becoming healthy children; Anora Products of Conception ("POC") test to rapidly and extensively analyze fetal chromosomes to understand the cause of miscarriage; Non-Invasive Paternity Testing ("PAT"), to determine paternity by analyzing the fragments of fetal deoxyribonucleic acid ("DNA") in a pregnant mother's blood and a blood sample from the alleged father(s), which is marketed and sold by a licensee from whom the Company receives a royalty. All testing is available principally in the United States and Europe. The Company also offers Constellation (“Constellation”), a cloud-based software product that allows laboratory customers to gain access through the cloud to the Company’s algorithms and bioinformatics in order to validate, launch and commercialize tests based on the Company’s technology.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. In the opinion of management, the unaudited interim condensed consolidated financial information includes only adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in stockholders’ equity, and cash flows. The results of operations for the three and nine months ended September 30, 2016, are not necessarily indicative of the results for the full year or the results for any future periods. The condensed consolidated balance sheet as of December 31, 2015 has been derived from audited financial statements at that date, these financial statements should be read in conjunction with the audited financial statements, and related notes for the year ended December 31, 2015 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 24, 2016.

Principles of Consolidation

The accompanying condensed consolidated financial statements include all the accounts of the Company and its subsidiary. The Company established a subsidiary that operates in the state of Texas in December 2014 to support the Company’s laboratory and operational functions, which became active in the second quarter of 2015. All intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Significant items subject to such estimates include the allowance for doubtful accounts, accrued liability for potential refund requests, stock-based compensation, the fair

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value of common stock and fair value of debt accounted for under ASC 815, as well as income tax uncertainties. These estimates and assumptions are based on management's best estimates and judgment. Management regularly evaluates its estimates and assumptions using historical experience and other factors; however, actual results could differ from these estimates and could have an adverse effect on the Company's financial statements.

Fair Value

The Company discloses the fair value of financial instruments for financial assets and liabilities for which the value is practicable to estimate. Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). Prior to repayment, the Company carried its senior secured term loan and currently carries its warrants at fair value according to the fair value measurement guidance.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and money market deposits with financial institutions.

Restricted Cash

The Company discloses both short-term and long-term restricted cash. Short-term restricted cash consists of $1.1 million, securing the Company’s letter of credit for its corporate headquarters operating leases, one of which expired in October 2016 and another which will expire in January 2017, and $0.1 million in payments received from certain customers. Long-term restricted cash consists of $0.3 million deposit per credit card terms.

Investments

Management determines the appropriate classification of securities at the time of purchase and reevaluates such determination at each balance sheet date. The Company generally classifies its entire investment portfolio as available-for-sale. The Company views its available-for-sale portfolio as available for use in current operations. Accordingly, the Company classifies all investments as short-term, even though the stated maturity may be more than one year from the current balance sheet date. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), which is a separate component of stockholders’ equity.

Risk and Uncertainties

Financial instruments that potentially subject the Company to credit risk consist of cash, accounts receivable and investments. The Company limits its exposure to credit loss by placing its cash in financial institutions with high credit ratings. The Company's cash may consist of deposits held with banks that may at times exceed federally insured limits. The Company performs evaluations of the relative credit standing of these financial institutions and limits the amount of credit exposure with any one institution.

The Company bills third-party payers for certain tests performed. The amount that is ultimately received from the payer for our claim and the timing of such payments are subject to the determination of the payer based on the nature of the test performed and their view of our business practices with respect to collections of plan deductibles and co-payments from patients and other activities. This determination can impact both the amount and timing of when our invoices are collected. Payers may also withhold payments and request refunds of prior payments if we do not perform in accordance with the policies of these payers.

The Company performs evaluations of financial conditions for clinics and laboratory partners and generally does not require collateral to support credit sales. For the three months ended September 30, 2016, one customer accounted for 13% of total revenues. There were no customers exceeding 10% of total revenues on an individual basis for the nine months ended September 30, 2016, and also for the three and nine months ended September 30, 2015. As of September 30, 2016, one customer had a receivable balance of approximately 28% of net accounts receivable, and as of December 31, 2015, there were no customers who had a balance greater than 10%.

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Revenue Recognition

The Company generally bills an insurance carrier, a clinic or a patient for tests it sells upon delivery of the test result. The Company also bills patients directly for out-of-pocket costs not covered by their insurance carriers representing co-pays and deductibles in accordance with their insurance carrier and health plans. The Company may not get reimbursed for tests completed if the tests are not covered under the insurance carrier’s reimbursement policies or the Company is not a qualified provider to the insurance carrier. For tests performed, where an agreed upon reimbursement rate or fixed fee and a predictable history or likelihood of collections exists, the Company recognizes revenues upon delivery of the test report to the prescribing physician based on the established billing rate less contractual and other adjustments, such as an allowance for doubtful accounts, to arrive at the amount that the Company expects to collect. In all other situations, as the Company does not have a sufficient history of collection and is not able to determine collectability, the Company recognizes revenues when cash is received. From time to time, we receive requests for refunds of payments previously made by insurance carriers. The Company has established an accrued liability for potential refund requests based on its experience.

In cases where the Company sells its tests through its laboratory partners, the majority of the laboratory partners bill the patient, clinic, or insurance carrier for the performance of the Company's tests.

For tests sold through a limited number of its laboratory partners, the Company bills directly to a patient, clinic or insurance carrier, or a combination of the insurance carrier and patient for the fees. The Company considers its services rendered when it delivers reports of its test results to the laboratory partner, clinic or patient. When the Company has contracted fixed rates for its services and collectability of its revenues is reasonably assured, it recognizes revenues upon delivery of test reports. The fixed fees identified in contracts with laboratory partners change only if a pricing amendment is agreed upon between both parties. For cases in which there is no fixed price established with a laboratory partner, the Company then recognizes revenues from partner distributed tests on a cash basis.

Certain of the Company's arrangements include multiple deliverables. For revenue arrangements with multiple deliverables, the Company evaluates each deliverable to determine whether it qualifies as a separate unit of accounting. This determination is based on whether the deliverable has "stand-alone value" to the customer and whether a general right of return exists. The consideration that is fixed or determinable is then allocated to each separate unit of accounting based on the relative selling price of each deliverable. The consideration allocated to each unit of accounting is recognized as the related goods or services are delivered, limited to the consideration that is not contingent upon future deliverables. The Company uses judgment in identifying the deliverables in its arrangements, assessing whether each deliverable is a separate unit of accounting, and in determining the best estimate of selling price for certain deliverables. The Company also uses judgment in determining the period over which the deliverables are recognized in certain of its arrangements. Any amounts received that do not meet the criteria for revenue recognition are recorded as deferred revenue until such criteria are met.

The Company receives royalty revenue through the licensing and the provisioning of services to support the use of the Company's proprietary technology with its licensee that commercializes PAT. Royalty revenues are recognized when earned under the terms of the related agreements and are included in Other Revenues in the statements of operations.

The Company recognizes revenue from its cloud-based distribution service offering, Constellation. The Company grants its licensees licenses to use the Company’s proprietary intellectual properties and the cloud-based Company software and provides other services to support the use of the Company's proprietary technology with its licensees. The Company’s proprietary software is used in connection with the analysis of DNA sequence data in a manner yielding a result indicating the likely presence or absence of full or partial chromosomal abnormalities. The licensees do not have the right to possess the Company’s software, but rather receive the software as a service. The revenues are recognized on an accrual basis (assuming all revenue recognition criteria are met) under the terms of the related agreements and are included in other revenues in the statements of operation.

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Stock‑Based Compensation

Stock‑based compensation is related to stock options and restricted stock units (“RSUs”) granted to the Company’s employees and is measured at the grant date based on the fair value of the award. The fair value is recognized as expense over the requisite service period, which is generally the vesting period of the respective awards. No compensation cost is recognized when the requisite service has not been met and the awards are therefore forfeited.

The Company uses the Black‑Scholes option‑pricing model to estimate the fair value of stock options issued to employees and non-employees. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest, and the resulting change in value, if any, is recognized in the Company's statements of operations during the period that the related services are rendered.

The Black-Scholes option-pricing model requires the input of the Company's expected stock price volatility, the expected life of the awards, a risk-free interest rate, and expected dividends. Determining these assumptions requires significant judgment. The expected term was based on the simplified method and the volatility rate was based on that of publicly traded companies in the DNA sequencing, diagnostics, or personalized medicine industries. When selecting the public companies in these industries to be used in the volatility calculation, companies were selected with comparable characteristics to the Company, including enterprise value and financial leverage. Companies were also selected with historical share price volatility sufficient to meet the expected life of the Company's stock options. The historical volatility data was computed using the daily closing prices for the selected companies' shares during the equivalent period of the calculated expected term of the Company's stock options. The expected life of the non-employee option grants was based on their remaining contractual life at the measurement date. The risk-free interest rate assumption was based on U.S. Treasury instruments with maturities that were consistent with the option's expected life. The expected dividend assumption was based on the Company's history and expectation of dividend payouts.

Warrants

The Company accounts for warrants to purchase shares of its common stock as a liability at fair value on the balance sheet date because the Company may be obligated to redeem these warrants at some point in the future. The warrants are subject to re-measurement at each balance sheet date, with changes in fair value of the warrants recognized as a gain or loss in interest and other income (expense), net in the statements of operations. The Company will continue to adjust the liability for changes in fair value until such time that the warrants are converted or expire.

Capitalized Software Held for Internal Use

The Company capitalizes costs of software purchased for internal use during the application development stage of a project and amortizes those costs over their estimated useful lives of three years. The net book value of capitalized software held for internal use was $1.5 million and $0.8 million as of September 30, 2016 and December 31, 2015, respectively. Amortized expense for the three months ended September 30, 2016 and 2015 was $0.2 million and $0.1 million, respectively. Amortized expense for the nine months ended September 30, 2016 and 2015 was $0.4 million and $0.2 million, respectively.

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Accumulated Other Comprehensive Loss

Comprehensive loss and its components encompass all changes in equity other than those with stockholders, and include net loss, unrealized gains and losses on available-for-sale marketable securities.


	Balance at						Balance at
	December 31,				Reclassification		September 30,
	2015		Increase		Adjustment		2016
	(in thousands)
Unrealized (loss) gain on available-for-sale securities, net of tax	$	(1,416)	$	1,941	$	(191)	$	334
Total accumulated other comprehensive (loss) income, net of tax	$	(1,416)	$	1,941	$	(191)	$	334

Net Loss per Share

Basic net loss per share is calculated by dividing net loss by the weighted-average shares outstanding during the period, without consideration for potential dilutive shares. Diluted net loss per share is calculated by adjusting the weighted-average shares outstanding for the dilutive effect of potential dilutive shares outstanding for the period, determined using the if-converted method. For purposes of the diluted net loss per share calculation, convertible preferred stock, stock options, convertible notes, unvested shares subject to repurchase, and warrants are considered potential dilutive shares but are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive. Therefore, basic and diluted net loss per share was the same for all periods presented.

Property and Equipment

Property and equipment, including purchased and internally developed software, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which are generally three years. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the assets or the remaining term of the lease, whichever is shorter. The Company periodically reviews the depreciable lives assigned to property and equipment placed in service and change the estimates of useful lives to reflect the results of such reviews. During the third quarter of 2016, the Company decreased the depreciable lives of certain sequencing and automation machinery and equipment to the end of the second quarter of 2017 based upon management’s estimated use. The effect of this change in estimate for the three and nine months ended September 30, 2016 was an increase in loss from operations and net loss of $0.4 million and $0.4 million, respectively. The effect of this change in estimate was an increase in net basic and diluted loss per share of $0.01 and $0.01 for the three and nine months ended September 30, 2016, respectively.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed below, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.

In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014‑15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014‑15). ASU 2014‑15 requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, companies will have reduced diversity in the timing and content of footnote disclosures compared to footnote disclosures under today’s guidance. ASU 2014‑15 is effective for the Company in the first quarter of 2016 with early adoption permitted. The Company does not believe the impact of adopting ASU 2014‑15 on its financial statements will be significant.

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014‑09, Revenue from Contracts with Customers (ASU 2014‑09) to provide guidance on revenue recognition. ASU 2014‑09

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requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09 for all entities by one year. The guidance is effective for the Company in the first quarter of 2018. ASU 2014-09, as amended by ASU 2015-14, is effective for interim or annual periods beginning after December 15, 2017. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU 2014‑09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The Company is currently evaluating the impact of adopting ASU 2014‑09 on its financial statements.

In July 2015, the Financial Accounting Standards Board issued Accounting Standards Update No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (ASU 2015-11). ASU 2015-11 simplifies the subsequent measurement of inventory by replacing today’s lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out (LIFO) and the retail inventory method (RIM). Entities that use LIFO or RIM will continue to use existing impairment models (e.g., entities using LIFO would apply the lower of cost or market test). The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, it is effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The Company believes the adoption of ASU 2015-11 will not result in any material impact on its financial statements.

In November 2015, the Financial Accounting Standards Board issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred taxes by requiring that deferred tax assets and liabilities be presented as noncurrent on the balance sheet. ASU 2015-17 is effective for the Company in the fiscal year beginning after December 15, 2016, and interim periods within those fiscal years. The Company believes the adoption of ASU 2015-17 will not result in any material impact on its financial statements.

In February 2016, the Financial Accounting Standards Board issued ASU 2016-02, Leases. ASU 2016-02 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. ASU 2016-2 is effective for the Company in the fiscal year beginning after December 15, 2018, and interim periods within those fiscal years with early adoption permitted. The Company is currently evaluating the impact of adopting ASU 2016-02 on its financial statements.

In March 2016, the Financial Accounting Standards Board issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Specifically, the ASU allows entities to withhold an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award and allowing forfeitures to be either estimated, as required today, or recognized when they occur. The new guidance will be effective for public entities in fiscal years beginning after December 15, 2016, with early adoption permitted. The Company believes the adoption of ASU 2016-09 will not result in any material impact of adopting ASU 2016-09 on its financial statements.

In August 2016, the Financial Accounting Standards Board issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the Emerging Issues Task Force). The purpose of ASU 2016-15 is to limit diversity in the classification of certain transactions in the statement of cash flows. Such transactions include (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon bonds, (3) contingent consideration payments made after a business combination, (4) proceeds from insurance claims settlement, (5) proceeds from settlement of life insurance policies, and (6) distributions of equity method investments. ASU 2016-15 will be effective for the Company in the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year. The Company is currently evaluating the impact of adopting ASU 2016-15 on its financial statements.

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3. Fair Value Measurements

The Company's financial assets and liabilities carried at fair value are comprised of investment assets that include money market and investments, and a liability for common stock warrants.

The fair value accounting guidance requires that assets and liabilities be carried at fair value and classified in one of the following three categories:

Level I: Quoted prices in active markets for identical assets and liabilities that the Company has the ability to access

Level II: Observable market‑based inputs or unobservable inputs that are corroborated by market data, such as quoted prices, interest rates, and yield curves

Level III: Inputs that are unobservable data points that are not corroborated by market data.

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

Assets and Liabilities That Are Measured at Fair Value on a Recurring Basis

The following table represents the fair value hierarchy for the Company’s financial assets and financial liabilities measured at fair value on a recurring basis:


	September 30, 2016								December 31, 2015
	Level I		Level II		Level III		Total		Level I		Level II		Level III		Total
	(in thousands)
Financial Assets:
Money market deposits	$	9,811	$	—	$	—	$	9,811	$	5,966	$	—	$	—	$	5,966
U.S. Treasury securities		75,565		—		—		75,565		103,813		—		—		103,813
U.S. agency securities		—		64,469		—		64,469		—		78,853		—		78,853
Municipal securities		—		17,683		—		17,683		—		18,920		—		18,920
Total financial assets	$	85,376	$	82,152	$	—	$	167,528	$	109,779	$	97,773	$	—	$	207,552

Current Liabilities:
Warrants	$	—	$	—	$	3,558	$	3,558	$	—	$	—	$	3,649	$	3,649
Total financial liabilities	$	—	$	—	$	3,558	$	3,558	$	—	$	—	$	3,649	$	3,649

During the nine months ended September 30, 2016, the Company did not make any transfers between Level I and Level II assets.

The Company's warrants to purchase common stock are valued using Level III inputs; the Company used inputs from a Black-Scholes model with market volatility that is determined for comparable companies in the same business sector. The carrying amounts of cash, accounts receivable, and accounts payable approximate their fair value and are excluded from the table above.

In April 2013, the Company entered into a senior secured term loan with a third‑party lender, which consisted of a credit agreement, royalty agreement, warrants, and loan commitment. The Company considered the guidance under ASC 825‑10, Financial Instruments, which provides a measurement basis election for most financial instruments (i.e., either

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historical cost or fair value), allowing reporting entities to mitigate potential mismatches that arise under the current mixed measurement attribute model and ASC 820, Fair Value Measurements and Disclosures that provides for the fair value measurement of assets and liabilities, except for derivatives, for which the fair value was determined by ASC 815, Derivatives and Hedging.

The Company evaluated the components of the senior secured term loan and determined that they were derivatives to be evaluated under ASC 815‑15‑25‑1. The fair value accounting for derivatives was not an option, as derivatives must be fair valued under ASC 815 following the measurement guidance under ASC 820. Therefore, the Company engaged a third party to determine the fair value of the derivatives using the guidance of ASC 820 and recorded the Senior Secured Term Loan at fair value.

ASC 815 requires the terms and features of an instrument that are not a derivative itself to be evaluated for embedded derivatives that must be bifurcated and separately accounted for as freestanding derivatives. In general, under ASC 815‑15‑25‑1, an embedded derivative is separated from the host contract and accounted for as a derivative instrument if certain criteria were met.

Based upon the Company's evaluation, the senior secured term loan constituted a liability with embedded derivative features that was accounted for separately as mark-to-market instruments. In addition, adjustments to the embedded royalty feature were recorded as interest expense as they occurred, offset to the carrying amount of the debt (with the eventual cash outlay to settle such amounts recorded against the carrying amount of the debt). Based on the Company's evaluation, it was determined that the warrants granted are detachable and therefore are a stand-alone component of the senior secured term loan to be fair valued using Level III inputs as a separate derivative. In October 2015, the Company repaid the entire borrowings under the senior secured term loan.

The following table provides a roll forward of the fair value, as determined by Level III inputs, of the warrants for the nine months ended September 30, 2016:


	Warrants
	(in thousands)
Balance at December 31, 2015	$	3,649
Change in fair value		(91)
Balance at September 30, 2016	$	3,558

Warrants

The significant unobservable inputs used in the fair value of warrants are derived from the Company's common stock valuation that is based upon a model with inputs from a Black-Scholes model and market volatility of 61.0% that was determined for comparable companies in the same business sector. The inherent risk in the market volatility is the selection of companies with similar business attributes to the Company.

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4. Financial Instruments

The Company elected to invest a portion of its cash assets in conservative, income earning, liquid investments effective September 2015. Cash equivalents and investments, all of which are classified as available-for-sale securities, consisted of the following:


	September 30, 2016								December 31, 2015
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized (Loss)		Estimated Fair Value		Amortized Cost		Gross Unrealized Gain		Gross Unrealized (Loss)		Estimated Fair Value
	(in thousands)
Money market deposits	$	9,811	$	—	$	—	$	9,811	$	5,966	$	—	$	—	$	5,966
U.S. Treasury securities		75,455		131		(21)		75,565		104,537		1		(725)		103,813
U.S. agency securities		64,299		183		(13)		64,469		79,491		—		(638)		78,853
Municipal securities		17,629		61		(7)		17,683		18,974		2		(56)		18,920
Total	$	167,194	$	375	$	(41)	$	167,528	$	208,968	$	3	$	(1,419)	$	207,552

Classified as:
Cash equivalents							$	9,811							$	5,966
Short-term investments								157,717								201,586
Total							$	167,528							$	207,552

The Company invests in U.S. Treasuries, U.S. agency and high quality municipal bonds which mature at par value and are all paying their coupons on schedule. The Company has therefore concluded there is currently no other than temporary impairment of its investments and will continue to recognize unrealized gains and losses in other comprehensive income (loss). During the three months ended September 30, 2016, the Company had immaterial realized gains and losses. During the nine months ended September 30, 2016, the Company had $0.2 million in realized gains and immaterial losses for a total net realized gain of $0.2 million. The Company uses the specific investment identification method to calculate realized gains and losses and amounts reclassified out of other comprehensive income to net income. As of September 30, 2016, the Company has nine investments in an unrealized loss position in its portfolio. The Company earned interest income of $0.4 million and $1.2 million, respectively, during the three and nine months ended September 30, 2016. The following table summarizes the Company’s portfolio of available-for-sale securities by contractual maturity as of September 30, 2016:


	September 30, 2016
	Amortized Cost		Fair Value
	(in thousands)
Less than one year	$	44,540	$	44,539
Greater than one year but less than five years		112,843		113,178
Total	$	157,383	$	157,717

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5. Balance Sheet Components

Property and Equipment, net

The Company’s property and equipment consisted of the following:


		September 30,		December 31,
	Useful Life	2016		2015
		(in thousands)
Machinery and equipment	3-5 years	$	22,926	$	20,670
Furniture and fixtures	3 years		493		217
Computer equipment	3 years		813		789
Capitalized software held for internal use	3 years		2,172		1,159
Leasehold improvements	Lesser of useful life or lease term		3,845		1,686
Construction-in-process			12,005		1,979
			42,254		26,500
Less: Accumulated depreciation and amortization			(16,638)		(13,790)
Total Property and Equipment, net		$	25,616	$	12,710

The Company periodically evaluates the carrying value of long-lived assets when events or circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the estimated realizable value of the asset is less than the carrying value of the asset. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined based on the estimated realizable value of the long-lived asset.

During the third quarter of 2016, the Company decreased the depreciable lives of certain sequencing and automation machinery and equipment to the end of the second quarter of 2017 based upon management’s estimated use. The effect of this change in estimate for both the three and nine months ended September 30, 2016 was an increase in loss from operations and net loss of $0.4 million. The effect of this change in estimate was an increase in net basic and diluted loss per share of $0.01 for both the three and nine months ended September 30, 2016.

Accrued Compensation

The Company’s accrued compensation consisted of the following:


	September 30,		December 31,
	2016		2015
	(in thousands)
Accrued paid time off	$	1,925	$	2,024
Accrued commissions		3,562		3,691
Accrued bonuses		2,309		1,348
Other accrued compensation		2,418		1,489
Total accrued compensation	$	10,214	$	8,552

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Other Accrued Liabilities

The Company’s other accrued liabilities consisted of the following:


	September 30,		December 31,
	2016		2015
	(in thousands)
Accrued expenses	$	22,959	$	17,870
Accrued rent		33		450
Deferred lease obligation		—		42
Sales and use tax payable		355		346
Total other accrued liabilities	$	23,347	$	18,708

In April 2016, the Company entered into a four-year agreement with an insurance carrier whereby in return for partial exclusivity and the right to pricing benefits the Company agreed to pay total consideration of $3.2 million. The total consideration was paid in the third quarter of 2016. As of September 30, 2016, $2.8 million in deferred cost was included in other long-term assets. The deferred costs are being amortized ratably over the four-year term of the agreement and for the three and nine months ended September 30, 2016, the Company amortized $0.2 million and $0.4 million, respectively, which was recorded as a reduction of product revenue.

6. Commitments and Contingencies

Operating Leases

As of September 30, 2016, the Company sub‑leases office facilities under non‑cancelable operating lease agreements. The Company occupies approximately 88,000 square feet of laboratory and office space at its corporate headquarters in San Carlos, California pursuant to two separate subleases. One sublease covers approximately 61,000 square feet (the “First Space”) and expired in October 2016, and the other sublease covers approximately 27,000 square feet (the “Second Space”) and will expire in January 2017. In connection with an amendment to the sublease agreement for the First Space in January 2013, the Company executed a letter of credit in favor of the lessors for $0.8 million, which is secured with a restricted cash account. In connection with its entry into the sublease for the Second Space in March 2014, the Company executed a letter of credit in April 2015 in favor of the lessors for $0.3 million, which is secured with a restricted cash account.

In October 2015, the Company entered into a lease agreement directly with the landlord of the First Space and the Second Space, the term of which (i) began in October 2016 with respect to the First Space and (ii) is expected to begin in January 2017 with respect to the Second Space, subject to the existing primary lessee of the Second Space not exercising its right to renew its existing lease for that space. The initial term of the lease will expire in October 2023, and may be extended for an additional five years. Upon the expiry of the current subleases, the lease agreement commenced in October 2016 at a monthly rent of $0.2 million per month, increasing each year thereafter to a maximum of $0.4 million in the final year of the initial term of the lease. The Company is entitled to a tenant improvement allowance of $0.4 million, to be expended prior to April 1, 2018, for the costs related to the design and construction of improvements to the facilities. The terms of the lease include a $0.5 million security deposit. As of September 30, 2016, the Company has a total of 86,504 square feet under lease at its San Carlos, California location.

In April 2015, the Company entered into a sub-lease agreement for additional office space in Redwood City, California. . The lease term for the additional space began in June 2015 and carried a base rent of $62,700 per month until its original termination date in August 2016, after which it was extended to November 2016 with a base rent of $88,331 per month. In addition, the Company has paid a security deposit of $125,500 for the additional space. As of September 30, 2016, the Company had a total of 23,245 square feet under sublease at its Redwood City, California location.

In September 2015, the Company’s subsidiary entered into a long-term lease agreement for laboratory and office space totaling approximately 94,000 square feet in Austin, Texas. The lease term was 132 months and began in December 2015 with monthly rent payments beginning in December 2016, increasing from $133,000 to $207,500. Pursuant to the

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terms of the lease, the subsidiary has paid a security deposit of $375,000, and the landlord has allotted the subsidiary an allowance for leasehold improvements of up to $7.8 million.

In October 2015, the Company’s subsidiary entered into a one-year lease agreement for additional temporary office space in Austin, Texas. The property carries a monthly rent of $12,900 per month for the 12 months of the lease and $12,900 per month on a month-to-month basis following the 12th month. The terms of the lease include a $12,900 security deposit. As of September 30, 2016, the Company has a total of 101,912 square feet under lease at its Austin, Texas location.

The future annual minimum lease payments under all non-cancelable operating leases as of September 30, 2016 are as follows:


	Operating Leases
	(in thousands)
Year ending December 31:
2016 (three months)	$	856
2017		5,441
2018		5,976
2019		6,140
2020		6,304
2021 and thereafter		25,923
Total future minimum lease payments	$	50,640

Rent expense for the three months ended September 30, 2016 and 2015 was $1.3 million and $0.7 million, respectively. Rent expense for the nine months ended September 30, 2016 and 2015 was $3.9 million and $1.8 million, respectively. The Company is also required to pay its share of facility operating expenses with respect to the facilities in which it operates.

Legal Proceedings

From time to time, the Company is involved in disputes, litigation, and other legal actions. The Company is aggressively defending its current litigation matters, and while there can be no assurances and the outcome of these matters is currently not determinable, the Company currently believes that there are no existing claims or proceedings that are likely to have a material adverse effect on its financial position. There are many uncertainties associated with any litigation and these actions or other third-party claims against the Company may cause the Company to incur costly litigation and/or substantial settlement charges.

In addition, the resolution of any intellectual property litigation may require the Company to make royalty payments, which could adversely affect gross margins in future periods. If this were to occur, the Company's business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from the Company's estimates, if any, which could result in the need to record or adjust a liability and record additional expenses. During the periods presented, the Company has not recorded any accrual for loss contingencies associated with such legal proceedings, determined that an unfavorable outcome is probable or reasonably possible, or determined that the amount or range of any possible loss is reasonably estimable.

On March 4, 2016, a lawsuit was filed against the Company in the Superior Court of the State of California for the County of San Diego seeking compensatory damages, alleging that the Company failed to perform a carrier screen test that was ordered for a patient who subsequently gave birth to a child with an inherited condition. The Company has notified its insurer, who is providing a defense under a reservation of rights. The Company intends to vigorously defend against the claims in this lawsuit, but it cannot be certain of the outcome.

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underwriters of its July 1, 2015 initial public offering (the "IPO"). The complaints assert claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, as amended. The complaints allege, among other things, that the Registration Statement and Prospectus for the Company’s IPO contained materially false or misleading statements, and/or omitted material information that was required to be disclosed, about the Company’s business and prospects. Among other relief, the complaints seek class certification, unspecified compensatory damages, rescission, attorneys' fees, and costs. The Company removed these actions to the United States District Court for the Northern District of California, and the actions were subsequently remanded to the San Mateo Superior Court. The Company has appealed the remand. The Company intends to defend the matter vigorously, but it cannot be certain of the outcome.

On January 6, 2012, the Company filed a declaratory judgment action in the U.S. District Court for the Northern District of California, alleging that U.S. Patent No. 6,258,540 licensed by Sequenom, Inc. ("Sequenom") from Isis Innovation Limited, Inc. ("Isis") (the '540 patent), is invalid, unenforceable and not infringed by the Company. The '540 patent relates to non-invasive prenatal diagnosis methods. This case was consolidated in the Northern District of California with a case that Sequenom, an affiliate of Sequenom, and Isis brought on January 24, 2012 in the Southern District of California alleging infringement by the Company and DNA Diagnostics Center, Inc., the Company's licensee, and at the time, the distributor of its non-invasive paternity test, of certain claims of the '540 patent. Ariosa Diagnostics, Inc. ("Ariosa") and Verinata Health, Inc. ("Verinata"), now a division of Illumina, Inc., also filed declaratory judgment actions regarding the '540 patent against Sequenom in the Northern District. Sequenom asserted counterclaims of infringement of the '540 patent against both Ariosa and Verinata in those respective cases. All of these cases were designated related cases. On October 30, 2013, the District Court issued an order granting Ariosa's motion for summary judgment in its case against Sequenom, finding that the claims asserted against Ariosa are invalid under 35 U.S.C. §101 for reciting non-patentable subject matter. Many of the claims of the '540 patent asserted against the Company were invalidated by this order. Subsequently, Sequenom entered into stipulations with Verinata and the Company conditionally agreeing that the remaining asserted claims of the '540 Patent should be deemed invalid under 35 U.S.C. §101. The Court then entered judgment in favor of Verinata and the Company in their respective cases in November 2013. Sequenom has appealed all three judgments to the Court of Appeals for the Federal Circuit ("CAFC"). The CAFC has consolidated the Ariosa, Verinata and the Company's cases for purposes of appeal, such that the CAFC can make a single ruling on the '540 patent claims that apply to all parties involved. The appellate arguments were heard on November 7, 2014. On December 2, 2014, Sequenom and Verinata settled the pending claims between them. On June 12, 2015, the CAFC affirmed the district court's finding of invalidity with respect to the Company and Ariosa. On August 13, 2015, Sequenom requested a rehearing en banc by the full panel of the CAFC, and on October 19, 2015, the Company and Ariosa each filed a response to Sequenom’s request. On December 2, 2015, Sequenom’s petition for a rehearing en banc was denied. On March 21, 2016, Sequenom filed a petition for writ of certiorari with the Supreme Court. Sequenom’s petition was denied on June 27, 2016, ending the litigation.

Third-Party Payer Reimbursement Audits

In November 2014, a third-party payer sought information as part of an investigative audit of claims that it had paid for certain genetic testing. The Company complied with the request and provided responsive information. In a letter dated June 2, 2015, the third-party payer alleged that it had overpaid $1.9 million to the Company, which it claimed was an overpayment reflecting the difference between what it paid to the Company and what it contended it should have paid based on its fee schedule and coverage determinations. In August 2015, the Company reached an agreement for a settlement payment of $1.2 million as part of a complete settlement of this matter. This charge was recorded against “revenue” in the second quarter of 2015.

Contractual Commitment

As of September 30, 2016, the Company has contractual commitments with a supplier for approximately $6.8 million and other material supplier commitments for approximately $1.1 million for inventory material used in the laboratory testing process.

In January 2015, the Company entered into a laboratory services agreement that required it to commit to a minimum purchase of certain genetic tests from a provider through October 2016. As of September 30, 2016, the Company had fully met the required minimum purchase commitments.

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7. Stock‑Based Compensation

2007 and 2015 Stock Plans

In January 2007, the Board of Directors (the Board) adopted, and the Company’s stockholders approved, the Company’s 2007 Stock Plan (the 2007 Plan), which was amended and restated on March 25, 2010 and amended on April 16, 2015. Pursuant to the 2007 Plan, stock options may be granted to employees, consultants, and outside directors of the Company. Options granted may be either incentive stock options or non-statutory stock options. Under the amended and restated 2007 Plan, the Company had reserved 15,999,289 shares of its common stock for issuance through March 31, 2016. The 2007 Plan was terminated in July 2015; however, the terms of the 2007 Plan will continue to govern any outstanding awards thereunder.

In June 2015, the Board adopted, and the Company’s stockholders approved, the Company’s 2015 Equity Incentive Plan (the 2015 Plan), which, by its terms, took effect as of the Company’s initial public offering on July 2, 2015. The Company reserved 3,451,495 shares of its common stock for issuance under the 2015 Plan; in addition, the Board and stockholders authorized the reservation of up to 9,890,310 shares of common stock to cover shares reserved but unissued under the 2007 Plan and shares subject to outstanding awards under the 2007 Plan that expire or lapse unexercised or shares issued under the 2007 Plan that are subsequently reacquired by the Company.

Employee Stock Purchase Plan

In the second quarter of 2015, shareholders approved the 2015 Natera, Inc. Employee Stock Purchase Plan (the “ESPP”), which became effective upon the Company’s initial public offering on July 2, 2015. Under the ESPP employees may purchase Natera, Inc. common stock through payroll deductions at a price equal to 85% of the lower of the fair market values of the stock as of the beginning or the end of six-month offering periods. An employee’s payroll deductions under the ESPP are limited to 15% of the employee’s compensation and employees may not purchase more than 5,000 shares of stock during any offering period. A participant shall not be granted an option under the ESPP if such option would permit the participant’s rights to purchase stock to accrue at a rate that exceeds $25,000 fair market value of stock for each calendar year in which such option is outstanding at any time. The Company has made 893,548 shares available for issuance under the Plan, a number that is automatically increased by the least of (i) 1% of the total number of shares of common stock actually issued and outstanding on the last business day of the prior fiscal year, (ii) 880,000 shares of common stock (subject to certain adjustments pursuant to Subsection (c) below), or (iii) a number of shares of common stock determined by the Board.

As of September 30, 2016, a total of 116,215 shares of common stock were issued under the ESPP and 1,280,981 shares are available for issuance.

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Stock Options

The following table summarizes option activity for the nine months ended September 30, 2016:


	Outstanding Options
					Weighted-
			Weighted-		Average
	Shares		Average		Remaining	Aggregate
	Available for	Number of	Exercise		Contractual	Intrinsic
(in thousands, except for contractual life and exercise price)	Grant	Shares	Price		Life	Value
					(In years)
Balance at December 31, 2015	3,743	9,316	$	3.96
Additional shares authorized	2,014	—
Options granted	(2,199)	2,199	$	10.06
Options exercised	—	(1,618)	$	1.68
Options forfeited/cancelled	751	(751)	$	8.15
Balance at September 30, 2016	4,309	9,146	$	5.47	7.70	$	53,338
Exercisable at September 30, 2016		4,819	$	2.75	6.59	$	40,763
Vested and expected to vest at September 30, 2016		8,761	$	5.33	7.62	$	52,219

Restricted Stock Awards

In February 2016, the Company granted 24,540 fully vested shares to a non-employee service provider.

Restricted Stock Units

In the nine months ended September 30, 2016, the Company issued restricted stock units to employees. The following table summarizes restricted stock unit activity for the nine months ended September 30, 2016:



			Weighted-
			Average
			Grant Date
(in thousands, except for grant date fair value)	Shares		Fair Value

Balance at December 31, 2015	—		—
Granted	210	$	9.75
Vested	(25)	$	9.59
Canceled/forfeited	(11)	$	9.74
Balance at September 30, 2016	174	$	9.78

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Stock‑Based Compensation Expense

Employee and non‑employee stock‑based compensation expense was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods, if actual forfeitures differ from those estimates.

The following tables present the effect of employee and non‑employee stock‑based compensation expense on selected statements of operations line items for the three and nine months ended September 30, 2016 and 2015.


	Three months ended September 30,
	2016						2015
	Employee		Non-Employee		Total		Employee		Non-Employee		Total
	(in thousands)
Cost of revenues	$	164	$	(4)	$	160	$	400	$	10	$	410
Research and development		784		(1)		783		266		2		268
Selling, general and administrative		1,716		14		1,730		1,491		(3)		1,488
Total	$	2,664	$	9	$	2,673	$	2,157	$	9	$	2,166


	Nine months ended September 30,
	2016						2015
	Employee		Non-Employee		Total		Employee		Non-Employee		Total
	(in thousands)
Cost of revenues	$	479	$	3	$	482	$	549	$	217	$	766
Research and development		2,105		(1)		2,104		824		24		848
Selling, general and administrative		5,117		262		5,379		3,202		90		3,292
Total	$	7,701	$	264	$	7,965	$	4,575	$	331	$	4,906

As of September 30, 2016, approximately $20.2 million of unrecognized compensation expense, adjusted for estimated forfeitures, related to unvested awards will be recognized over a weighted‑average period of approximately 2.9 years.

Valuation of Stock Option Grants to Employees

The Company estimates the fair value of its stock options granted to employees on the grant date using the Black‑Scholes option‑pricing model. The fair value of employee stock options is amortized on a straight‑line basis over the requisite service period of the awards, generally the vesting period. The fair value of employee stock options was estimated using the following assumptions:


	Three months ended September 30,										Nine months ended September 30,
	2016					2015					2016					2015
Expected term				5.2		5.7		—	6.1		5.1		—	5.2		5.6		—	6.5
Expected volatility	69.0	%	—	72.5	%	69.7	%	—	71.9	%	68.5	%	—	72.5	%	69.7	%	—	78.8	%
Expected dividend rate				0	%				0	%				0	%				0	%
Risk-free interest rate	0.97	%	—	1.12	%	1.65	%	—	1.80	%	0.97	%	—	1.24	%	1.56	%	—	1.96	%

Expected Term: The expected term of options represents the period of time that options are expected to be outstanding. The Company's historical stock option exercise experience does not provide a reasonable basis upon which to estimate an expected term due to a lack of sufficient data. The Company estimates the expected term by using the simplified method permitted by the Securities and Exchange Commission. The simplified method calculates the expected term as the average of the time-to-vesting and the contractual life of the options.

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Expected Volatility: The Company derived the expected volatility from the average historical volatilities of comparable publicly traded companies within its peer group over a period approximately equal to the expected term.

Expected Dividend Rate: The Company has not paid and does not anticipate paying any dividends in the near future.

Risk-Free Interest Rate: The risk-free interest rate assumption is based on U.S. Treasury yield in effect at the time of grant for zero coupon U. S. Treasury notes with maturities approximately equal to the expected term.

8. Debt

Credit Line Agreement

In September 2015, the Company entered into the Credit Line with UBS (the “Credit Line”) providing for a $50.0 million revolving line of credit that can be drawn down in increments at any time. In October 2015, the Company borrowed $32.0 million against the Credit Line, primarily to prepay all outstanding amounts under the Secured Loan Arrangement with ROS Acquisition Offshore, LP (the “Secured Loan Arrangement”). The Credit Line bears interest at 30-day LIBOR plus 0.65% per annum which resulted in an effective rate of interest of 1.1% for the each of the three and nine months ended September 30, 2016. In November 2015, the Company borrowed an additional $10.0 million which increased the principal balance to $42.0 million. In June 2016, the Company repaid $1.0 million on the Credit Line and borrowed $8.0 million resulting in a remaining $0.7 million available under the Credit Line net of accrued interest of $0.3 million. The Credit Line is secured by a first priority lien and security interest in the Company’s money market and marketable securities held in its managed investment account with UBS. UBS has the right to demand full or partial payment of the Credit Line obligations and terminate the Credit Line, in its discretion and without cause, at any time.

9. Warrants

Under the terms of the Senior Secured Term Loan, the Company granted approximately 376,691 warrants to purchase common stock with an exercise price of $2.3229 per common share, which expire on April 18, 2023. In connection with the IPO in July 2015, these warrants remain exercisable for common stock.

10. Income Taxes

During the third quarter of 2016, the Company began providing testing to clinics that were based in a foreign country, which attributed to a foreign income tax expense of $0.1 million for the three and nine months ended September 30, 2016. The Company recorded zero income tax expense for the three and nine months ended September 30, 2015. During these periods, the Company’s activities were primarily limited to U.S. federal and state tax jurisdictions. The federal and state effective tax rate is approximately 37% before research and development credits and permanent adjustments related to stock-based compensation and mark to market adjustments on warrants.

Due to the Company’s history of cumulative operating losses, management concluded that, after considering all the available objective evidence, it is not more likely than not that all the Company’s net deferred tax assets will be realized. Accordingly, all of the Company’s deferred tax assets, which includes net operating loss or NOL carryforwards and tax credits related primarily to research and development continue to be subject to a valuation allowance as of September 30, 2016. The Company will continue to maintain a full valuation allowance until there is sufficient evidence to support recoverability of its deferred tax assets.

The Company had $3.2 million and $2.4 million in unrecognized tax benefits at September 30, 2016 and December 31, 2015, respectively. The reversal of the uncertain tax benefits would not affect the effective tax rate to the extent that the Company continues to maintain a full valuation allowance against its deferred tax assets. Unrecognized tax benefits may change during the next twelve months for items that arise in the ordinary course of business.

Interest and/or penalties related to income tax matters are recognized as a component of income tax expense. As of September 30, 2016, there were no accrued interest and penalties related to uncertain tax positions.

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11. Net Loss per Share

Basic and diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding for the period, excluding shares subject to repurchase and without consideration of potentially dilutive securities. The Company's potential dilutive shares, which include outstanding common stock options, unvested common shares subject to repurchase, convertible preferred stock and warrants, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the effect would be to reduce the net loss per share.

The following table provides the basic and diluted net loss per share computations for the three and nine months ended September 30, 2016 and 2015.


	Three months ended				Nine months ended
	September 30,				September 30,
(in thousands, except per share data)	2016		2015		2016		2015

Basic and diluted loss per share:
Net loss	$	(26,017)	$	(17,630)	$	(57,858)	$	(47,315)

Weighted-average common shares outstanding		52,012		46,380		51,422		20,252
Less: weighted-average unvested common shares subject to repurchase		—		(1,436)		(121)		(1,531)
Weighted-average number of shares used in computing net loss per share, basic and diluted		52,012		44,944		51,301		18,721

Basic and diluted net loss per share	$	(0.50)	$	(0.39)	$	(1.13)	$	(2.53)

Potentially dilutive shares that were not included in the diluted per share calculations because they would be anti‑dilutive as of September 30, 2016 and 2015 were as follows:


	September 30,
	2016	2015
	(in thousands)
Options to purchase common stock	9,146	9,399
Warrants to purchase common stock	377	410
Restricted stock units	174	—
Employee stock purchase plan	145	—
Common stock subject to repurchase	—	1,403
	9,842	11,212

12. Geographic Information

The following table presents total revenues by geographic area based on the location of the Company’s customers:


	Three months ended				Nine months ended
	September 30,				September 30,
(in thousands)	2016		2015		2016		2015

United States	$	48,125	$	38,709	$	149,436	$	118,091
Americas, excluding U.S.		688		1,128		1,991		3,635
Europe, Middle East, India, Africa		3,223		3,804		11,122		11,786
Other		1,853		1,280		5,226		3,932
Total	$	53,889	$	44,921	$	167,775	$	137,444

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13. Subsequent Events

On October 6, 2016, the Company amended the lease agreement it directly entered into with the landlord of its First Space and Second Space (as described in Note 6) to include an additional sublease of office space. The additional sublease covers approximately 48,000 square feet of office space and consists of two phases. The first phase began in October 2016 and covers approximately 16,000 square feet of office space at a base rent of $60,730 per month. The second phase, which covers approximately 32,000 square feet of office space at a base rent of $121,460 per month, is expected to begin in January 2017, as the Company progresses with its expansion. The term of this sublease is approximately eighty-four months, with the same expiration date as the First Space and Second Space, which is in October 2023.

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this report.

Overview

We are a rapidly growing diagnostics company with proprietary molecular and bioinformatics technology that we are deploying to change the management of genetic disease worldwide. Our novel molecular assays reliably measure many informative regions across the genome from samples as small as a single cell. Our statistical algorithms combine these measurements with data available from the broader scientific community to detect a wide range of serious conditions with best in class accuracy and coverage. In addition to our direct sales force in the United States, we have a global network of over 70 laboratory and distribution partners, including many of the largest international laboratories. We are enabling even wider adoption of our technology by introducing a global cloud-based distribution model. We have launched seven molecular diagnostic tests since 2009, and we intend to launch new products in prenatal testing and oncology in the future. We generate revenues primarily from the sale of Panorama, our non-invasive prenatal test, or NIPT, which we commercially launched in March 2013. Over 254,000 Panorama tests were accessioned during the year ended December 31, 2015 and over 247,000 Panorama tests were accessioned during the nine months ended September 30, 2016. Our revenues have grown from $4.3 million in 2010 to $190.4 million in the year ended December 31, 2015, and from $137.4 million in the nine months ended September 30, 2015 to $167.8 million in the nine months ended September 30, 2016.

We were formed in 2003 under our former name, Gene Security Network. From 2006 through 2013, the National Institutes of Health awarded us cumulative grants of $5.7 million to conduct various research projects including non-invasive aneuploidy screening on circulating fetal cells for prenatal diagnosis. An initial period of research and development was followed by the commercialization of Spectrum Preimplantation Genetic Screening (PGS) in 2009 and Spectrum Preimplantation Genetic Diagnosis (PGD) in 2010; Anora Products of Conception (POC) in 2010; our non-invasive prenatal paternity test in 2011; Horizon Carrier Screen (HCS) in 2012; Panorama NIPT in 2013; our microdeletions panel for Panorama in 2014; and Constellation in 2015.

In the nine months ended September 30, 2016 and year ended December 31, 2015, we processed most of our tests in our laboratory certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, in San Carlos, California. A significant portion of our Horizon Carrier Screening testing is performed by third-party laboratories. During the nine months ended September 30, 2016, we accessioned greater than 318,000 tests, including greater than 247,000 Panorama tests. In the year ended December 31, 2015, we accessioned greater than 310,000 tests, including greater than 254,000 Panorama tests. Our customers include independent laboratories, national and regional reference laboratories, medical centers and physician practices. We market and sell our tests both through our sales force and those of our laboratory partners. We bill clinics, laboratory partners, patients and insurance payers for the tests we perform. In most of the cases where we bill laboratory and distribution partners, our partners in turn bill clinics, patients and insurance payers. Insurers reimburse for NIPT procedures based on positive coverage determinations, which means that the insurer has determined that NIPT in general is medically necessary for this category of patient. In the United States, the payers with positive NIPT coverage determinations include UnitedHealthCare, AETNA, Anthem, Humana and CIGNA. We and our laboratory partners have in-network contracts with insurance providers that account for approximately 200 million commercial covered lives in the United States. A "covered life" means a subscriber, or a dependent of a subscriber, who is insured under an insurance policy with the insurance carrier identified. The number of covered lives represented by insurers that have positive coverage determinations or with which we or our laboratory partners have a contract provides a measure of our access to the healthcare market. Although our target market for NIPT is a much smaller subset of the total number of covered lives because it excludes subscribers for whom our NIPT would not be performed, such as men, children and post-menopausal women, we believe the number of U.S. covered lives for whom we have access under contract represents an important indicator of our access to the total available market for our products. Insurers also reimburse for our products through out-of-network claims submission processes where we do not have a contract with that insurer.

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The principal focus of our commercial operations currently is to distribute molecular diagnostic tests through both our direct sales force and laboratory partners, and the number of tests that we accession is a key indicator that we use to assess our business. A test is accessioned when we receive the test, the relevant information about the test is entered into our computer system and the test sample is routed into the appropriate sample flow. We accessioned over 318,000 tests during the nine months ended September 30, 2016, compared to over 217,000 tests during the nine months ended September 30, 2015. This increase in volume is primarily due to the commercial growth of our Panorama and Horizon carrier screening tests. We significantly increased the number of our domestic sales representatives in the third quarter of 2014 through the second quarter of 2015 in an effort to increase the number of tests distributed through our direct sales force. The percent of our revenues attributable to our U.S. direct sales force for the nine months ended September 30, 2016 was 79%, up from 76% for the nine months ended September 30, 2015. The percent of our revenues attributable to U.S. laboratory partners for the nine months ended September 30, 2016 was 11%, up from 10% for the nine months ended September 30, 2015. Our ability to increase our revenues and gross profit will depend on our ability to further penetrate the U.S. market with our direct sales force. The percent of our revenues attributable to international laboratory partners and other international sales for the nine months ended September 30, 2016 was 11%, down from 14% for the nine months ended September 30, 2015.

In addition to distributing molecular diagnostic tests through our direct sales force and laboratory partners, we seek to establish licensing arrangements with laboratories under our cloud-based distribution model, whereby our laboratory licensees run the molecular workflows themselves and then access our bioinformatics algorithms through our cloud-based Constellation software. This cloud-based distribution model results in lower revenues and gross profit per test than in cases where we process a test ourselves; however, because we don’t incur the costs of processing the tests, our costs per test under this model are also lower. In February 2014, we entered into a licensing and service arrangement with DNA Diagnostics Center, Inc., or DDC, to enable the development of a non-invasive prenatal paternity test based on our proprietary technology. DDC commercializes this test, and we receive royalty revenues from DDC. We have recognized $2.3 million and $1.6 million in revenues from our licensing arrangements during the nine months ended September 30, 2016 and 2015, respectively. The DDC arrangement commenced in the second quarter of 2014 and our other arrangements commenced beginning in the fourth quarter of 2015.

Our revenues increased to $167.8 million in the nine months ended September 30, 2016 from $137.4 million in the nine months ended September 30, 2015. Panorama revenues accounted for $108.7 million, or 65%, of our revenues for the nine months ended September 30, 2016 and $104.4 million, or 76%, of our revenues for the nine months ended September 30, 2015. A significant proportion of our revenues in the three months ended September 30, 2016 were derived from in-network payer contracts. For the three months ended September 30, 2016, one of our customers, BioReference, accounted for 13% of total revenues. For the nine months ended September 30, 2016, there were no customers exceeding 10% of total revenue on an individual basis. Sales of Panorama to Bio-Reference represented 11% and 5% of our revenues generated from Panorama in the nine months ended September 30, 2016 and 2015, respectively. Revenues from customers outside the United States were $18.3 million and $19.4 million for the nine months ended September 30, 2016 and 2015, respectively. Most of our revenues have been denominated in U.S. dollars, but we began to generate revenue in foreign currency in 2015, primarily denominated in Euros. For the nine months ended September 30, 2016 and 2015, approximately 11% and 14%, respectively, of our revenues were generated in international markets.

Our net losses for the nine months ended September 30, 2016 and 2015 were $57.9 million and $47.3 million, respectively. This included non-cash stock compensation expense of $8.0 million and $4.9 million for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016, we had an accumulated deficit of $307.9 million.

Components of the Results of Operations

Revenues

We generate revenues from the sale of our genetic tests, primarily from the sale of our NIPT, Panorama. We assess whether fees are fixed or determinable based on the nature of the fee charged for the services delivered and existing contractual arrangements. For tests performed where an agreed upon reimbursement rate or fixed fee and a predictable history or likelihood of collections exists, we recognize revenues upon delivery of a report to the prescribing physician or

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clinic based on the established billing rate less contractual and other adjustments, such as an allowance for doubtful accounts, to arrive at the amount that we expect to collect. In all other situations, as we do not have a fixed or determinable price, a sufficient history of collection or we are not able to determine the price for our test, we recognize revenue when cash is received.

Our two primary distribution channels are our direct sales force and our laboratory and distribution partners. We have also recently implemented a cloud-based distribution model from which we began recognizing revenue in the fourth quarter of 2015. In cases where we promote our tests through our direct sales force, we generally bill directly to a patient, clinic or insurance carrier, or a combination of the insurance carrier and patient for the fees. We do not maintain an account receivable balance in our financial statements for outstanding billing to the insurance payers because we cannot determine the collectable portion of the billings until cash is received.

In cases where we sell our tests through our laboratory partners, the large majority of our laboratory partners bill the patient, clinic or insurance carrier for the performance of our tests and we are entitled to either a fixed price per test or a percentage of their collections. The fixed fees identified in contracts with laboratory partners change only if a pricing amendment is agreed upon between both parties. In contracts whereby we have a fixed fee agreement, revenue is recognized when collection is reasonably assured and all other revenue recognition criteria is met. For cases in which there is no fixed price established with a laboratory partner, we then recognize revenues from partner distributed tests on a cash basis. For tests sold through a limited number of our laboratory partners, we bill directly to a patient, clinic or insurance carrier, or a combination of the insurance carrier and patient for the fees.

Revenue recognized on a cash basis represented 81% and 77% of our revenues for the three months ended September 30, 2016 and 2015, respectively. Revenue recognized on a cash basis represented 85% and 80% of our revenues for the nine months ended September 30, 2016 and 2015, respectively. The increase in revenue recognized on a cash basis for the three and nine months ended September 30, 2016 versus September 30, 2015 is primarily due to increased volumes with cash basis customers. As of September 30, 2016, we have 21 licensing and service arrangements with laboratories under our cloud-based distribution model. For the three and nine months ended September 30, 2016, we recognized revenue from six of such arrangements.

Our ability to increase our revenues will depend on our ability to further penetrate the domestic and international markets and, in particular, generate sales through our direct sales force, offer additional tests, obtain reimbursement from additional third-party payers and increase our reimbursement rate for tests performed. In particular, our financial performance depends on reimbursement for Panorama in the average risk population and for microdeletions. The use of Panorama in the average risk population is not yet broadly reimbursed, although some third-party payers have begun to reimburse for this, and we believe that more third-party payers will do so in the future. Many third-party payers do not currently reimburse for microdeletions screening, as further discussed in the risk factor entitled “Reimbursement and Regulatory Risks Related to Our Business— If we are unable to expand or maintain third-party payer coverage and reimbursement for Panorama and our other tests, or if we are required to refund any reimbursements already received, our revenues and results of operations would be adversely affected,” because there is currently limited published data on the performance of microdeletions screening tests. A new current procedure terminology, or CPT, code for microdeletions is scheduled to go into effect beginning January 1, 2017. We anticipate that this new code could, in the near term, cause our microdeletions reimbursement to decline, either due to reduced reimbursement, or third-party payers declining to reimburse, under the new code. Any such decline in reimbursement would decrease our revenues. Our financial performance is also impacted by our increase in in-network coverage with third-party payers, which we believe is crucial to our growth and long-term success. However, because the negotiated fees under our contracts with third-party payers are typically lower than the list price of our tests, as we enter into additional in-network contracts with insurance providers, our average reimbursement per test has decreased. While we expect the reduction in average reimbursement per test from in-network pricing to reduce our revenues and gross margins in the near term, in-network pricing is more predictable than out-of-network pricing and we will continue to mitigate the impact by driving more business from our most profitable accounts. In addition, our strategy to offer our tests to laboratory licensees via our cloud-based Constellation platform, if successful, may also cause our revenues to decrease because we do not process the tests and perform the molecular biology analysis in our own laboratory under this model, and therefore are not able to charge as high an amount, and as a result realize lower revenues, per test than when we perform the entire test ourselves.

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Cost of Product Revenues

The components of our cost of product revenues are materials and service costs, personnel costs, including stock-based compensation expense, equipment and infrastructure expenses associated with testing samples, electronic medical record, order and delivery systems, shipping charges to transport samples, third-party test fees and allocated overhead including rent, information technology costs, equipment depreciation and utilities. Costs associated with performing tests are recorded when the test is processed regardless of whether and when revenues are recognized with respect to that test. As a result, our cost of product revenues as a percentage of revenues may vary significantly from period to period because we do not recognize all revenues in the period in which the associated costs are incurred. We expect cost of product revenues in absolute dollars to increase as the number of tests we perform increases.

However, having rapidly achieved scale, we have increased our focus on more efficient use of labor, automation, and DNA sequencing. For example, we have recently updated the molecular and bioinformatics process for Panorama to further reduce the sequencing reagents, test steps and associated labor costs required to obtain a test result, while increasing the sensitivity of the test to allow it to run with lower fetal fraction input. These improvements also reduced the frequency of the need to require blood redraws from the patient. In addition, we are continuing to grow our cloud-based distribution network. This model reduces sample shipping, labor, and material costs at our CLIA-certified laboratory in California. Five of our laboratory licensees have begun running tests developed under license from us in their own laboratories, leaving us to provide only the algorithmic data analysis in the cloud through our Constellation software and software maintenance. We have agreements with various other laboratories and are in active discussions with many other potential licensees under this distribution model.

Research and Development

Research and development expenses include costs incurred to develop our technology, collect clinical samples and conduct clinical studies to develop and support our products. These costs consist of personnel costs, including stock-based compensation expense, prototype materials, laboratory supplies, consulting costs, regulatory costs, electronic medical record set up costs, costs associated with setting up and conducting clinical studies at domestic and international sites and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses will increase in absolute dollars in future periods as we continue to invest in research and development activities related to developing additional products. In the near term we will continue to grow research and development expenses in support of Panorama and other new products and programs, including the application of our proprietary technologies for cancer and other disease detection.

Selling, General and Administrative

Selling, general and administrative expenses include executive, selling and marketing, legal, finance and accounting, human resources, billing and client services. These expenses consist of personnel costs, including stock-based compensation expense, direct marketing expenses, audit and legal expenses, consulting costs, education seminars, payer outreach programs and allocated overhead, including rent, information technology, equipment depreciation, and utilities. In the near term, we expect selling, general and administrative expenses will increase and be driven by the costs of hiring additional sales personnel to further penetrate the domestic and international market and marketing and education expenses to drive market penetration and reimbursement. We also expect selling, general and administrative expenses to continue to increase as a result of becoming a public company. These expenses are related to compliance with the rules and regulations of the Securities and Exchange Commission and the Nasdaq Global Select Market, additional insurance expenses, investor relations activities and other administrative and professional services. We also expect our selling, general and administrative expenses will increase in absolute dollars as we expand our billing and client services functions.

Interest Expense

Interest expense is attributable to borrowing under our senior secured term loan and our equipment financing facility prior to repayment and our line of credit. We also recognized revenue-based royalties to the lender associated with our senior secured term loan prior to prepayment as part of interest expense.

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Interest Benefit (Expense) from Changes in the Fair Value of Long-Term Debt

Interest benefit (expense) also arose from changes in the fair value associated with our senior secured term loan prior to repayment.

Interest and Other Income (Expense), Net

Interest and other income (expense), net is from interest earned on our cash, realized gains on investments, foreign currency re-measurement gains and other expense related to the changes in the fair value of our warrants.

Critical Accounting Policies

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We consider our critical accounting policies and estimates to be revenue recognition, income taxes, fair value measurements and stock-based compensation. There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2016 from those disclosed in our Annual Report on Form 10-K filed with the SEC on March 24, 2016. We periodically review the depreciable lives assigned to property and equipment placed in service and change the estimates of useful lives to reflect the results of such reviews. The effect of this change in estimate for both the three and nine months ended September 30, 2016 was an increase in loss from operations and net loss of $0.4 million.

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Results of operations

Comparison of the three months ended September 30, 2016 and 2015


	Three months ended
	September 30,				Increase /		% Increase /
	2016		2015		(Decrease)		(Decrease)
		(In thousands except percentage)
Revenues
Product revenues	$	53,090	$	44,423	$	8,667	19.5	%
Other revenues		799		498		301	60.4
Total revenues		53,889		44,921		8,968	20.0
Cost and expenses:
Cost of product revenues		34,261		30,456		3,805	12.5
Research and development		11,345		7,336		4,009	54.6
Selling, general and administrative		34,938		27,870		7,068	25.4
Total cost and expenses		80,544		65,662		14,882	22.7
Loss from operations		(26,655)		(20,741)		(5,914)	28.5
Interest expense		(146)		(1,177)		1,031	(87.6)
Interest benefit from changes in the fair value of long term debt		—		1,810		(1,810)	(100.0)
Interest and other income		887		2,478		(1,591)	(64.2)
Loss before income taxes		(25,914)		(17,630)		(8,284)	47.0
Income tax expense		(103)		—		(103)	100.0
Net loss	$	(26,017)	$	(17,630)	$	(8,387)	47.6	%

Revenues

Revenues increased $9.0 million, or 20.0%, from the three months ended September 30, 2015 to the three months ended September 30, 2016. This was primarily due to increase in volume of Panorama and Horizon carrier screening tests performed during the quarter. Approximately 53% of our revenues during the three months ended September 30, 2016 were derived from test volumes accessioned in the quarter ended September 30, 2016; the balance of our revenues was derived from tests accessioned in prior periods. Panorama revenue increased $3.8 million during the three months ended September 30, 2016 compared to the three months ended September 30, 2015 due to higher volumes, improved collections for tests accessioned in prior periods, and improved pricing from part of our laboratory partner channel. HCS revenue increased $6.0 million during the three months ended September 30, 2016 compared to the three months ended September 30, 2015 primarily due to increased HCS tests. Royalty revenues increased $0.3 million, and revenues from other products decreased $1.0 million, during the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

During the three months ended September 30, 2016, we accessioned greater than 109,100 tests, including greater than 84,400 Panorama tests and greater than 20,500 Horizon carrier screening tests. We recognized revenue on greater than 67,000 tests, including greater than 55,000 Panorama tests and greater than 9,600 Horizon carrier screening tests in the three months ended September 30, 2016. Fifty-one percent of the 67,000 tests, including 53% of the 55,000 Panorama tests and 43% of the 9,600 Horizon carrier screening tests were accessioned in the three months ended September 30, 2016 and the remainder were accessioned in prior periods. During the three months ended September 30, 2015, we accessioned greater than 83,000 tests, including greater than 67,000 Panorama tests and greater than 13,000 Horizon carrier screening tests and recognized revenue on greater than 35,000 tests, including greater than 31,000 Panorama tests and greater than 2,800 Horizon carrier screening tests. Fifty-four percent of the 35,000 tests, including 55% of the 31,000 Panorama tests and 41% of the 2,800 Horizon carrier screening tests, were accessioned in the three months ended September 30, 2015 and the remainder were accessioned in prior periods.

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The number of tests we accession in a given period differs from the number of tests on which we recognize revenue in that period because we recognize revenue for most tests upon cash receipt, which may occur a number of months after the test is accessioned; and in some cases, we do not ultimately receive reimbursement or payment for tests we accession. The vast majority of tests distributed through our direct sales force are billed to insurance payers and revenue is predominantly recognized on a cash basis as price is not fixed and determinable and collection is not reasonably assured. The decrease in the percentage of tests that are both accessioned and recognized as revenue within the same quarter in the three months ended September 30, 2016 compared to the three months ended September 30, 2015 is related to improved collections from tests accessioned in prior periods.

Revenues from customers outside the United States were $5.8 million and $6.2 million for the three months ended September 30, 2016 and 2015, respectively.

Cost of product revenues

Cost of product revenues increased $3.8 million, or 12.5%, during the three months ended September 30, 2016 compared to the three months ended September 30, 2015 primarily due to an increase in the volume of tests performed in the quarter combined with an increase in material and personnel costs, which are directly related to the growth in Panorama and HCS tests performed in the three months ended September 30, 2016. As a percentage of total revenues, cost of product revenues decreased 4.2% year over year from 67.8% of revenues for the three months ended September 30, 2015 to 63.6% for the three months ended September 30, 2016. Our cost of product revenues per test decreased in the three months ended September 30, 2016 compared to the three months ended September 30, 2015 as a result of innovations that allowed us to streamline our laboratory workflows and other laboratory-related efficiencies. The percentage of our revenues attributable to cost of product revenues is impacted because we continued to derive Panorama volume growth in the average risk population, which is not yet broadly reimbursed.

Research and development

Research and development expenses increased $4.0 million, or 54.6%, during the three months ended September 30, 2016 compared to the three months ended September 30, 2015. The increase in research and development expenses was primarily attributable to a $2.2 million increase in salaries and personnel‑related costs associated with an increase in research and development headcount, a $1.2 million increase in outside services costs, a $0.2 million increase in expenses associated with clinical trials performed for our potential future product offerings, and $0.1 million of facility-related costs.

Selling, general and administrative

Selling, general and administrative expenses increased $7.0 million, or 25.3%, in the three months ended September 30, 2016 compared to the three months ended September 30, 2015. The increase in selling, general and administrative expenses was primarily attributable to increases in general and administrative costs and headcount increases that we have incurred since our July 2015 initial public offering. Significant increases in the three months ended September 30, 2016 versus the three months ended September 30, 2015 include a $3.0 million increase in salaries and personnel‑related costs and $0.5 million increase in office expenses due to higher headcount, increases in outside service costs of $1.7 million, and increases in marketing expenses of $0.8 million for corporate events and public relations. Facilities expenses increased $0.4 million in the three months ended September 30, 2016 versus the three months ended September 30, 2015 primarily due to lease expenses for the addition of our Austin, Texas facility and increased lease rental expense for our California facilities.

Interest expense

Interest expense decreased $1.0 million, or 87.6%, in the three months ended September 30, 2016 compared to the three months ended September 30, 2015 primarily due to the payoff of the higher interest rate senior secured term loan, see “Liquidity and Capital Resources—Senior Secured Term Loan,” compared to the lower interest rate on the line of credit, see “Liquidity and Capital Resources—Credit Line Agreement.”

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Interest benefit from changes in the fair value of long-term debt

Interest benefit from changes in the fair value of long-term debt decreased from $1.8 million during the three months ended September 30, 2015 to zero in the three months ended September 30, 2016 due to the payment in full of the senior secured loan in October 2015.

Interest and other income

Interest and other income decreased $1.7 million for the three months ended September 30, 2016 compared to the three months ended September 30, 2015 primarily due to a $2.0 million unfavorable movement on the change in the fair value of our warrant obligation, offset by a $0.3 million increase in interest income earned on investments.

Comparison of the nine months ended September 30, 2016 and 2015


	Nine Months Ended
	September 30,				Increase /		% Increase /
	2016		2015		(Decrease)		(Decrease)
		(In thousands except percentage)
Revenues:
Product revenues	$	165,457	$	135,841	$	29,616	21.8	%
Other revenues		2,318		1,603		715	44.6
Total revenues		167,775		137,444		30,331	22.1
Cost and expenses:
Cost of product revenues		97,574		81,032		16,542	20.4
Research and development		30,403		19,707		10,696	54.3
Selling, general and administrative		98,573		79,195		19,378	24.5
Total cost and expenses		226,550		179,934		46,616	25.9
Loss from operations		(58,775)		(42,490)		(16,285)	38.3
Interest expense		(383)		(3,391)		3,008	(88.7)
Interest expense from changes in the fair value of long-term debt		—		(312)		312	(100.0)
Interest and other income (expense), net		1,403		(1,122)		2,525	(225.0)
Loss before income taxes		(57,755)		(47,315)		(10,440)	22.1
Income tax expense		(103)		—		(103)	100.0
Net loss	$	(57,858)	$	(47,315)	$	(10,543)	22.3	%

Revenues

Revenues increased $30.3 million, or 22.1%, from the nine months ended September 30, 2015 to the nine months ended September 30, 2016. This was primarily due to increase in volume of Panorama and Horizon carrier screening tests performed. Panorama revenue increased $4.2 million during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 due to increased Panorama volumes offset by decreases in insurance carrier reimbursements. HCS revenue increased $27.7 million during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 due to increased HCS volumes. Royalty revenues increased $0.7 million, and revenues from other products decreased $2.4 million during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

During the nine months ended September 30, 2016, we accessioned greater than 318,000 tests, including greater than 247,000 Panorama tests and greater than 58,800 Horizon carrier screening tests. We recognized revenue on greater than 158,000 tests, including greater than 129,000 Panorama tests and greater than 23,000 Horizon carrier screening tests in the nine months ended September 30, 2016. Seventy-seven percent of the 158,000 tests, including 78% of the 129,000 Panorama tests and 75% of the 23,000 Horizon carrier screening tests, were accessioned in the nine months ended September 30, 2016 and the remainder were accessioned in prior periods. During the nine months ended September 30, 2015, we accessioned greater than 217,000 tests, including greater than 181,000 Panorama tests and greater than 26,000

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Horizon carrier screening tests. We recognized revenue on greater than 99,000 tests, including greater than 86,000 Panorama tests and greater than 8,400 Horizon carrier screening tests, in the nine months ended September 30, 2015. Seventy-nine percent of the 99,000 tests, including 80% of the 86,000 Panorama tests and 65% of the 8,400 Horizon carrier screening tests, were accessioned in the nine months ended September 30, 2015 and the remainder were accessioned in prior periods.

The number of tests we accession in a given period differs from the number of tests on which we recognize revenue in that period because we recognize revenue for most tests upon cash receipt, which may occur a number of months after the test is accessioned; and in some cases, we do not ultimately receive reimbursement or payment for tests we accession. The vast majority of tests distributed through our direct sales force are billed to insurance payers and revenue is predominantly recognized on a cash basis as price is not fixed and determinable and collection is not reasonably assured. The decrease in the percentage of tests that are both accessioned and recognized as revenue within the same quarter in the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 is related to improved collections from tests accessioned in prior periods.

Revenues from customers outside the United States were $18.3 million and $19.4 million for the nine months ended September 30, 2016 and 2015, respectively, due to a decrease in royalty revenue.

Cost of product revenues

Cost of product revenues increased $16.5 million, or 20.4%, during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 primarily due to an increase in the volume of tests performed in the quarter combined with an increase in material and personnel costs, which are directly related to the growth in Panorama and HCS tests performed in the nine months ended September 30, 2016. As a percentage of total revenues, cost of product revenues decreased 0.8% year over year, at 58.2% for the nine months ended September 30, 2016 versus 59.0% for the nine months ended September 30, 2015. Our cost of product revenues per test decreased in the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 as a result of innovations that allowed us to streamline our laboratory workflows and other laboratory-related efficiencies. The percentage of our revenues attributable to cost of product revenues is impacted because we continued to derive Panorama volume growth in the average risk population, which is not yet broadly reimbursed.

Research and development

Research and development expenses increased $10.7 million, or 54.3%, during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. The increase in research and development expenses was primarily attributable to a $7.0 million increase in salaries and personnel‑related costs associated with an increase in research and development headcount, as well as a $2.3 million increase in outside services costs, and a $0.9 million increase in office, facilities and other expenses.

Selling, general and administrative

Selling, general and administrative expenses increased $19.4 million, or 24.4%, during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. The increase in selling, general and administrative expenses was primarily attributable to increases in general and administrative costs and headcount increases that we have incurred since our July 2015 initial public offering. Significant increases include a $8.6 million increase in salaries and personnel‑related costs, including a 5% increase in employees and contractor headcount, a $1.4 million increase in travel expenses due to increased selling activity and a $3.1 million increase in outside services costs, primary related to other consulting fees. Office expenses increased $1.8 million and facilities expenses increased $1.7 million, primarily due to a $1.5 million increase in facility expenses related to our Austin, Texas location and $0.2 million related to facility expenses for our California locations. Other corporate expenses increased by $1.5 million primarily due to increased business insurance costs.

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Interest expense

Interest expense decreased $3.0 million, or 88.7%, in the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015, primarily due to the payoff of the higher interest rate senior secured term loan, see “Liquidity and Capital Resources—Senior Secured Term Loan,” compared to the interest rate on the line of credit. See “Liquidity and Capital Resources—Credit Line Agreement.”

Interest expense from changes in the fair value of long-term debt

Interest expense from changes in the fair value of long-term debt decreased $0.3 million for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 due to the payment in full of the senior secured loan in October 2015.

Interest and other income (expense), net

Interest and other income (expense), net increased $2.4 million, or 214.1%, for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 primarily due to a $1.6 million favorable movement on the change in the fair value of our warrant obligation and a $1.1 million increase in interest income earned on investments, offset by a $0.4 million decrease in other income from the previous year.

Liquidity and Capital Resources

We have incurred net losses each year since our inception. For the nine months ended September 30, 2016, we had a net loss of $57.9 million, and we expect to incur additional losses in future periods. As of September 30, 2016, we had an accumulated deficit of $307.9 million.

To date, we have funded our operations primarily with the net proceeds from our initial public offering (“IPO”), sales of our preferred stock and convertible promissory notes, borrowings under our senior secured term loan arrangement with ROS Acquisition Offshore LP, our credit facilities with a commercial bank and revenues from operations. We also received a total of $5.7 million of grant income from the National Institutes of Health between 2006 and 2013. As of September 30, 2016, we had $25.3 million in cash and cash equivalents, $1.5 million of restricted cash and $157.7 million in short-term investments.

Initial Public Offering

In July 2015, we completed an IPO, and subsequently in August 2015, we completed the sale of additional shares upon exercise of the underwriters’ over-allotment option. In connection with the IPO, we sold 10,900,000 shares of common stock at $18.00 per share, which raised $178.5 million in proceeds, net of underwriting discounts, commissions, and offering expenses.

Senior Secured Term Loan

In April 2013, we entered into a senior secured term loan arrangement with ROS Acquisition Offshore, LP, as amended June 6, 2014, which we refer to as the Secured Loan Arrangement, for $40.0 million in aggregate borrowing capacity, of which we borrowed $20.0 million. The Secured Loan Arrangement consisted of a term loan, or Credit Agreement, a warrant to purchase 376,691 shares of common stock with an exercise price of $2.3229 per share (which expires in April 2023) and an agreement to pay royalties on our revenues, or Royalty Agreement. In October 2015, we prepaid the entire amount outstanding under the Secured Loan Arrangement, comprising $20.0 million in principal, $2.0 million (10% of the outstanding principal) in prepayment penalty, and a $6.0 million (including third quarter 2015 and payoff expense) royalty payment applied toward the royalty obligation. This prepayment terminated the loan, royalty and all associated liens securing the Secured Loan Arrangement.

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Credit Line Agreement

In September 2015, we entered into the Credit Line with UBS providing for a $50.0 million revolving line of credit that can be drawn down in increments at any time. In October 2015, we borrowed $32.0 million against the Credit Line, primarily to prepay all outstanding amounts under the Secured Loan Arrangement with ROS Acquisition Offshore, LP. The Credit Line bears interest at 30-day LIBOR plus 0.65% per annum which resulted in an effective rate of interest of 1.1% for each of the three and six months ended September 30, 2016. In November 2015, we borrowed an additional $10.0 million which increased the principal balance to $42.0 million. In June 2016, we repaid $1.0 million on the Credit Line and borrowed $8.0 million resulting in a remaining $0.7 million available under the Credit Line net of accrued interest of $0.3 million. The Credit Line is secured by a first priority lien and security interest in our money market and marketable securities accounts held in our managed investment account with UBS. UBS has the right to demand full or partial payment of the Credit Line obligations and terminate the Credit Line, in its discretion and without cause, at any time.

Cash Flows

Our primary uses of cash are to fund our operations as we continue to grow our business. We expect to continue to incur operating losses in the future as our operating expenses increase to support the growth of our business. We expect that our research and development, and selling, general and administrative expenses will continue to increase as we expand our marketing efforts and support our internal sales force to drive increased adoption of and reimbursement for Panorama, continue our research and development efforts with respect to expanding Panorama's and Horizon's capabilities and further developing our product pipeline. Cash used to fund operating expenses is impacted by the timing of when we pay expenses, as reflected in the change in our outstanding accounts payable and accrued expenses.

Based on our current business plan, we believe that our existing cash and marketable securities will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Management may elect, however, to finance operations by selling additional equity securities. If additional funding is required or desired, we cannot assure you that additional funds will be available to us on acceptable terms on a timely basis, if at all, or that we will generate sufficient cash from operations to adequately fund our operating needs or achieve or sustain profitability. If we are unable to raise additional capital or generate sufficient cash from operations to adequately fund our operations, we will need to curtail planned activities to reduce costs. Doing so will likely have an adverse effect on our ability to execute on our business plan. If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition, and results of operations could be adversely affected.

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


	Nine Months Ended
	September 30,
	2016		2015
	(In thousands)
Cash used in operating activities	$	(44,406)	$	(33,143)
Cash provided by (used in) investing activities		30,089		(32,805)
Cash provided by financing activities		10,692		174,964
Net (decrease) increase in cash		(3,625)		109,016
Cash at beginning of year		28,947		87,176
Cash at end of period	$	25,322	$	196,192

Cash Used in Operating Activities

Cash used in operating activities during the nine months ended September 30, 2016 was $44.4 million. The net loss of $57.9 million includes $14.1 million in non‑cash charges resulting from $4.2 million of depreciation and amortization, $8.0 million of stock compensation expense, $1.1 million in investment security premium amortization, a $0.1 million remeasurement gain on the change in the fair value of warrants and other non‑cash charges of $0.6 million. Increases in operating assets reduced cash by $12.1 million due to a $3.9 million increase in accounts receivable, a $1.2 million increase in inventory, $3.0 million increase in other assets and a $4.0 million increase in prepaid assets and

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restricted cash. Increases in operating liabilities increased cash by $11.4 million due to increases in accounts payable of $1.7 million, accrued compensation of $1.7 million, other accrued liabilities of $1.6 million, deferred rent of $6.1 million, and deferred revenue of $0.4 million.

Cash used in operating activities during the nine months ended September 30, 2015 was $33.1 million. The net loss of $47.3 million reflects non‑cash charges of $4.4 million of depreciation and amortization, $4.9 million of stock compensation expense and a $1.8 million charge from the change in the value of long‑term debt and warrants, $1.3 million impairment on assets, and other non-cash charges of $0.3 million. The increase in net operating assets of $6.6 million was primarily due to a $1.9 million increase in inventory, an increase in prepaid assets and other current assets of $3.7 million, an increase in accounts receivable of $0.2 million, and an increase in other assets and restricted cash of $0.9 million. Operating liabilities increased by $8.1 million primarily driven by increases in accounts payable of $0.1 million and accrued compensation of $1.6 million, and other accrued liabilities of $6.3 million.

Cash Provided by (Used in) Investing Activities

Cash provided by investing activities for the nine months ended September 30, 2016 totaled $30.1 million, which was comprised of $44.7 million in investment proceeds net of purchases and the acquisition of $14.6 million of property and equipment, net of proceeds. Acquisitions of property and equipment are primarily related to the build out of our Austin, Texas diagnostic testing facility and purchases of computer hardware and software.

Cash used in investing activities for the nine months ended September 30, 2015 totaled $32.8 million and was primarily related to $26.4 million of investments and the acquisition of $6.5 million of property and equipment.

Cash Provided by Financing Activities

Cash provided by financing activities for the nine months ended September 30, 2016 totaled $10.7 million consisting of a net $7.0 million in short term borrowings under our Credit Line and $3.7 million from the issuance of common stock.

Cash provided by financing activities for the nine months ended September 30, 2015 was $175.0 million consisting primarily of proceeds from issuance of common stock, net of $180.6 million, proceeds from collection of officer receivable of $0.2 million, which were offset by repayments of the Equipment Financing Facility of $5.9 million.

Contractual Obligations and Other Commitments

See “Liquidity and Capital Resources” for a description of our contractual obligations under the Credit Agreement, Royalty Agreement and the Equipment Financing Facility. The Royalty Agreement and Equipment Financing Facility were paid-off in full October and September 2015, respectively.

The following table summarizes our contractual obligations as of September 30, 2016:


	Payments Due by Period
			Less Than		1 to 3		3 to 5		More Than
	Total		1 Year		Years		Years		5 Years
	(In thousands)
Operating leases	$	50,640	$	4,937	$	11,942	$	12,691	$	21,070
Short-term debt(1)		49,000		49,000		—		—		—
Interest on short-term debt(2)		473		473		—		—		—
Inventory purchase obligations(3)		7,874		7,874		—		—		—
Total	$	107,987	$	62,284	$	11,942	$	12,691	$	21,070

(1)

Represents proceeds drawn from our Credit Line.

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(2)

Represent our accrued interest as of September 30, 2016 on our Credit Line.

(3)

Represents material open inventory purchase orders in the aggregate with suppliers as of September 30, 2016, including a contractual commitment with Illumina, Inc. for $6.8 million for inventory material used in the laboratory testing process through October 2016.

Operating Lease Obligations

As of September 30, 2016, we sub‑lease office facilities under non‑cancelable operating lease agreements. We occupy approximately 88,000 square feet of laboratory and office space at our corporate headquarters in San Carlos, California pursuant to two separate subleases. One sublease covers approximately 61,000 square feet (the “First Space”) and expired in October 2016, and the other sublease covers approximately 27,000 square feet (the “Second Space”) and will expire in January 2017. In connection with an amendment to the sublease agreement for the First Space in January 2013, we executed a letter of credit in favor of the lessors for $0.8 million, which is secured with a restricted cash account. In connection with our entry into the sublease for the Second Space in March 2014, we executed a letter of credit in April 2015 in favor of the lessors for $0.3 million, which is secured with a restricted cash account.

On October 6, 2016, we amended the lease agreement that we directly entered into with the landlord of our First Space and Second Space (as described above) to include an additional sublease of office space to accommodate our growth and consolidate our operations in California at one location. The additional sublease covers approximately 48,000 square feet of office space and consists of two phases. The first phase began in October 2016 and covers approximately 16,000 square feet of office space at a base rent of $60,730 per month. The second phase, which covers approximately 32,000 square feet of office space at a base rent of $121,460 per month, is expected to begin in January 2017, as the Company progresses with its expansion. The term of this sublease is approximately eighty-four months, with the same expiration date as the First Space and Second Space, which is in October 2023.

In October 2015, we entered into a lease agreement directly with the landlord of the First Space and the Second Space, the term of which (i) began in October 2016 with respect to the First Space and (ii) is expected to begin in January 2017 with respect to the Second Space, subject to the existing primary lessee of the Second Space not exercising its right to renew its existing lease for that space. The initial term of the lease will expire in October 2023, and may be extended for an additional five years. Upon the expiry of the current subleases, the lease agreement commenced in October 2016 at a monthly rent of $0.2 million per month, increasing each year thereafter to a maximum of $0.4 million in the final year of the initial term of the lease. We are entitled to a tenant improvement allowance of $0.4 million, to be expended prior to April 1, 2018, for the costs related to the design and construction of improvements to the facilities. The terms of the lease include a $0.5 million security deposit. As of September 30, 2016, we had a total of 86,504 square feet under lease at our San Carlos, California location.

In April 2015, we entered into a sub-lease agreement for additional office space in Redwood City, California. The lease term for the additional space began in June 2015 and carried a base rent of $62,700 per month until its original termination date in August 2016, after which it was extended to November 2016 with a base rent of $88,331 per month. In addition, we paid a security deposit of $125,500 for the additional space. As of September 30, 2016, we had a total of 23,245 square feet under sublease at our Redwood City, California location.

In September 2015, our subsidiary entered into a long-term lease agreement for laboratory and office space totaling approximately 94,000 square feet in Austin, Texas. The lease term was 132 months and began in December 2015 with monthly rent payments beginning in December 2016, increasing from $133,000 to $207,500. Pursuant to the terms of the lease, the subsidiary has paid a security deposit of $375,000, and the landlord has allotted the subsidiary an allowance for leasehold improvements of up to $7.8 million.

In October 2015, our subsidiary entered into a one-year lease agreement for additional temporary office space in Austin, Texas. The property carries a monthly rent of $12,900 per month for the 12 months of the lease and $12,900 per month on a month-to-month basis following the 12th month. The terms of the lease include a $12,900 security deposit. As of September 30, 2016, we had a total of 101,912 square feet under lease at our Austin, Texas location.

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We amortize our leasehold improvements allowance over the entire life of the lease contract on a straight-line basis as an offset to monthly rent expense. Monthly rent expense is calculated by summing all of the rent payments over the life of the lease and calculating the monthly rent expense on a straight-line basis by dividing the sum of all payments over the life of the lease by the number of months in the lease contract. Monthly rent expense is then offset by the amortization of leasehold improvements allowance when applicable.

Inventory Purchase Obligations

As of September 30, 2016, we have contractual commitments with Illumina, Inc. and other material suppliers for approximately $6.8 million and $1.1 million, respectively, for inventory material used in the laboratory testing process. This represents binding and future minimum purchase obligations through October 31, 2016.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

JOBS Act Accounting Election

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or 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 3:QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily relate to interest rates. Our Credit Line has an interest rate of one-month LIBOR plus 0.65%. The LIBOR rate is variable. An incremental change in the borrowing rate of 100 basis points would increase our annual interest expense by $0.5 million based on our $49.5 million outstanding under the Credit Line including principal and accrued interest as of September 30, 2016.

Our investment portfolio is exposed to market risk from changes in interest rates. This risk is mitigated as we have maintained a relatively short average maturity for our investment portfolio. If a 100 basis point change in interest rates were to occur to our investments in 2016, our interest income would change by approximately $1.6 million annually in relation to amounts we would expect to earn, based on our cash, cash equivalents, and short-term investments as of September 30, 2016.

Foreign Currency Exchange Rate Fluctuations

Our operations are currently conducted primarily in the United States. As we expand internationally, our results of operations and cash flows may become subject to fluctuations due to changes in foreign currency exchange rates. In periods when the U.S. dollar declines in value as compared to the foreign currencies in which we incur expenses, our foreign‑currency based expenses will increase when translated into U.S. dollars. In addition, future fluctuations in the value of the U.S. dollar may affect the price at which we sell our tests outside the United States. To date, our foreign currency risk has been minimal and we have not historically hedged our foreign currency risk; however, we may consider doing so in the future.

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ITEM 4:CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2016. The term “disclosure controls and procedures,” as defined in Rule 13a-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Based on the evaluation of our disclosure controls and procedures as of September 30, 2016, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II – OTHER INFORMATION

ITEM 1.LEGAL PROCEEDINGS

From time to time, we are involved in legal proceedings. The results of such legal proceedings and claims cannot be predicted with certainty, and regardless of the outcome, legal proceedings could have an adverse impact on us because of defense and settlement costs, diversion of resources and other factors.

On January 6, 2012, we filed a declaratory judgment action in the U.S. District Court for the Northern District of California, alleging that U.S. Patent No. 6,258,540 licensed by Sequenom from Isis Innovation Limited, Inc., or the '540 patent, is invalid, unenforceable and not infringed by us. The '540 patent relates to non-invasive prenatal diagnosis methods. This case was consolidated in the Northern District of California with a case that Sequenom, an affiliate of Sequenom, and Isis brought on January 24, 2012 in the Southern District of California alleging infringement by us and

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DDC, the licensee, and at the time, the distributor, of our non-invasive paternity test, of certain claims of the '540 patent. Ariosa and Verinata also filed declaratory judgment actions regarding the '540 patent against Sequenom in the Northern District. Sequenom asserted counterclaims of infringement of the '540 patent against both Ariosa and Verinata in those respective cases. All of these cases were designated related cases. On October 30, 2013, the District Court issued an order granting Ariosa's motion for summary judgment in its case against Sequenom, finding that the claims asserted against Ariosa are invalid under 35 U.S.C. §101 for reciting non-patentable subject matter. Many of the claims of the '540 patent asserted against us were invalidated by this order. Subsequently, Sequenom entered into stipulations with Verinata and us conditionally agreeing that the remaining asserted claims of the '540 Patent should be deemed invalid under 35 U.S.C. §101. The Court then entered judgment in favor of Verinata and us in the respective cases in November 2013. Sequenom has appealed all three judgments to the Court of Appeals for the Federal Circuit, or CAFC. The CAFC consolidated the Ariosa, Verinata and our cases for purposes of appeal, such that the CAFC would be able to make a single ruling on the '540 patent claims that apply to all parties involved. The appellate arguments were heard on November 7, 2014. On December 2, 2014, Sequenom and Verinata settled the pending claims between them. On June 12, 2015, the CAFC affirmed the district court's finding of invalidity with respect to us and Ariosa. On August 13, 2015, Sequenom requested a rehearing en banc by the full panel of the CAFC, and on October 19, 2015, we and Ariosa each filed a response to Sequenom’s request. On December 2, 2015, Sequenom’s petition for a rehearing en banc was denied. On March 21, 2016, Sequenom filed a petition for writ of certiorari with the Supreme Court. Sequenom’s petition was denied on June 27, 2016, ending the litigation.

On February 17, 2016, March 10, 2016, March 28, 2016 and April 4, 2016, four purported class action lawsuits were filed in the Superior Court of the State of California for the County of San Mateo (the “San Mateo Superior Court”), against Natera, our directors and certain of our officers and 5% stockholders and their affiliates, and each of the underwriters of our July 1, 2015 initial public offering (the "IPO"). The complaints assert claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, as amended. The complaints allege, among other things, that the Registration Statement and Prospectus for our IPO contained materially false or misleading statements, and/or omitted material information that was required to be disclosed, about our business and prospects. Among other relief, the complaints seek class certification, unspecified compensatory damages, rescission, attorneys' fees, and costs. We removed these actions to the United States District Court for the Northern District of California, and the actions were subsequently remanded to the San Mateo Superior Court. We have appealed the remand. We intend to defend these matters vigorously, but cannot provide any assurance as to the ultimate outcome.

On March 4, 2016, a lawsuit was filed against us in the Superior Court of the State of California for the County of San Diego seeking compensatory damages, alleging that Natera failed to perform a carrier screen test that was ordered for a patient who subsequently gave birth to a child with an inherited condition. We intend to vigorously defend against the claims in this lawsuit, but cannot provide any assurance as to the ultimate outcome.

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ITEM 1A.RISK FACTORS

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this report, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our condensed consolidated financial statements and related notes, before investing in our common stock. The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occurs, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that event, the price of our common stock could decline and you could lose part or all of your investment.

Risks Related to Our Business and Industry

We derive most of our revenues from Panorama, and if our efforts to further increase the use and adoption of Panorama or to develop new products in the future do not succeed, our business will be harmed.

For the three months ended September 30, 2016 and the year ended December 31, 2015, 65% and 73%, respectively, of our revenues were derived from sales of our NIPT, Panorama. Although we derive some revenues from our other products, we expect to continue to derive a significant portion of our revenues from the sales of Panorama, at least in the near term. Continued and additional market acceptance of Panorama and our ability, through our direct sales efforts and through laboratory partners and licensees, to attract new customers are key elements to our future success. The market demand for NIPTs has grown in recent periods and is evolving, but this market trend may not continue or, even if it does continue to grow, physicians may not recommend and order Panorama, and our laboratory partners and licensees may not actively or effectively market Panorama.

Our ability to increase sales and establish significant levels of adoption and reimbursement for Panorama is uncertain, and we may never be able to achieve profitability for many reasons, including, among others:

the NIPT market may not grow as we expect, and NIPTs may not gain acceptance for use in the average-risk pregnancy population or as a screen for microdeletions, which would limit the market for Panorama;

laboratories, clinics, clinicians, physicians, payers and patients may not adopt use of Panorama on a broad basis, and may not be willing to pay the price premium over other NIPTs that we have, to date, been able to achieve, if we are unable to demonstrate to these constituencies that Panorama is superior to competing NIPTs;

third-party payers, such as commercial insurance companies and government insurance programs, may decide not to reimburse for Panorama, may not reimburse for uses of Panorama for the average-risk pregnancy population or for the screening of microdeletions, or may set the amounts of such reimbursements at prices that do not allow us to cover our expenses; in fact, most third-party payers currently have negative coverage determinations for average-risk patient populations, some third-party payers do not reimburse for microdeletions screening and we expect reimbursement for microdeletions screening to continue to decrease in the near term, and most state Medicaid programs currently either reimburse at low rates or do not reimburse for our tests;

the results of our clinical trials and any additional clinical and economic utility data that we may develop, present and publish or that comes from the commercial use of Panorama may be inconsistent with prior data, may raise questions about the performance of Panorama, or may fail to convince laboratories, clinics, clinicians, physicians, payers or patients of the value of Panorama;

we, our laboratory partners or licensees may not be able to maintain and grow effective sales and marketing capabilities, and our sales and marketing efforts may fail to effectively reach customers or effectively communicate the benefits of Panorama;

our laboratory partners may choose to offer tests provided by our competitors due to pricing or other reasons as has happened in the past, or otherwise fail to effectively market Panorama;

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we may experience supply constraints, including due to the failure of our key suppliers to provide required sequencers and reagents, including with respect to the required sequencers and reagents from our supplier, Illumina, Inc., which is also one of our main competitors through its Verinata division;

we may not be successful in our efforts to reduce our cost of product revenues, and as we result may experience increased cost of product revenues as a percentage of total revenues, as has been the case in past quarters and for the year ended December 31, 2015 compared to the respective prior periods;

the U.S. Food and Drug Administration, or the FDA, or other U.S. or foreign regulatory or legislative bodies may adopt new regulations or policies, or take other actions that impose significant restrictions on our ability to market and sell Panorama or our other tests, including requiring FDA clearance or approval for the sale of Panorama or of the sequencers, reagents, kits and other consumable products that we purchase from third parties in order to perform our testing;

a more effective and/or less expensive test for risk assessment of chromosome conditions in fetuses may be developed and commercialized; and

we may fail to adequately protect our intellectual property relating to Panorama or others may claim we infringe their intellectual property rights.

If the market for Panorama or our market share fail to grow or grow more slowly than expected, our business, operating results and financial condition will be harmed.

We have incurred losses since our inception and we anticipate that we will continue to incur losses for the foreseeable future, which could harm our future business prospects.

We have incurred net losses each year since our inception in 2003. To date, we have financed our operations primarily through private placements of preferred stock, convertible debt and other debt instruments, and our initial public offering. Our net loss for the years ended December 31, 2015, 2014 and 2013 was $70.3 million, $5.2 million and $37.1 million, respectively. Our net loss for the three months ended September 30, 2016 and 2015 was $26.0 million and $17.6 million, respectively. As of September 30, 2016 and December 31, 2015, we had an accumulated deficit of $307.9 million and $250.1 million, respectively. We expect that such losses will increase in the future as we continue to devote a substantial portion of our resources to efforts to increase adoption of, and reimbursement for, Panorama and our other products, improve these products, and research and develop future diagnostic solutions, including in the field of cancer. In addition, the rate of growth in our revenues has generally been low or flat in recent quarters. Furthermore, a significant element of our business strategy has been, and will continue to be, to increase our in-network coverage with third-party payers; however, the negotiated fees under our contracts with third-party payers are typically lower than the list price of our tests, and in some cases the third-party payers that we contract with have negative coverage determinations for some of our offerings, such as Panorama for the average-risk pregnancy population. Therefore, going in-network with third-party payers can have an adverse impact on our revenues if we are unable to increase adoption of, and favorable coverage determinations for reimbursement for, our products.

As a result of our limited operating history, our ability to forecast our future operating results, including revenues, cash flows and profitability, is limited and subject to a number of uncertainties. We have also encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in the life sciences and technology industry, such as those described in this report. If our assumptions regarding these risks and uncertainties are incorrect or these risks and uncertainties change due to changes in our markets, or if we do not address these risks successfully, our operating and financial results may differ materially from our expectations, and our business may suffer.

Uncertainty in the development and commercialization of our enhanced or new tests, including future cancer products, could materially adversely affect our business, financial condition and results of operations.

Our success will depend in part on our ability to effectively introduce enhanced or new tests. We continue to focus our research and development efforts on prenatal products, with an increasing effort to expand our platform and apply our expertise in processing and analyzing cell free DNA to the field of cancer. The development of enhanced or new tests is complex, costly and uncertain. In particular, we are subject to the risk that the biological characteristics of the

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genetic mutations we seek to target, and upon which our technologies rely, are uncertain and difficult to predict. For example, in our efforts to detect and analyze circulating tumor DNA in plasma, our success depends on tumors shedding mutant DNA into the bloodstream in sufficient quantities such that our technology can detect such mutations. Furthermore, enhancing or developing new tests requires us to accurately anticipate patients', clinicians' and payers' attitudes and needs and emerging technology trends. We may experience research and development, regulatory, marketing and other difficulties that could delay or prevent our introduction of enhanced or new tests. The research and development process in molecular diagnostics generally takes a significant amount of time from the research and design stage to commercialization. This process is conducted in various stages, and each stage presents the risk that we will not achieve our goals. For example, any tests that we may enhance or develop may not prove to be clinically effective in clinical trials or otherwise, or we may otherwise have to abandon a test in which we have invested substantial resources. We are currently in the process of developing updates to Panorama which we believe will reduce the costs of running the test and further improve its performance. However, we may experience delays or other difficulties in our development efforts, resulting in increased costs and the diversion of management’s attention and resources from other business matters. Any such delays may also lead to challenges in sourcing components of our technology to the extent that such components are updated by the supplier, or otherwise become obsolete, before we complete the development of our updates.

The launch of any new diagnostic tests, including those in the field of cancer diagnostics, requires the completion of certain clinical development and commercialization activities and the expenditure of additional cash resources. Clinical development requires large numbers of patient specimens and, for certain products, may require large, prospective, and controlled clinical trials. We may not be able to enroll patients or collect a sufficient number of appropriate specimens in a timely manner to complete clinical development for any planned diagnostic test, or we may be unable to afford or manage the large-sized clinical trials that some of our planned future products may require. We cannot assure you that we can successfully complete the clinical development of any other diagnostic test, or that we can establish or maintain the collaborative relationships that may be essential to our clinical development and commercialization efforts. Such failures could prevent or significantly delay our ability to research, develop, complete clinical development and validation, obtain FDA clearance or approval as may be necessary or desired, or launch any of our planned diagnostic tests, including those in the field of cancer diagnostics. Any failure to complete on-going clinical studies for our planned diagnostic tests could have a material adverse effect on our business, operating results or financial condition.

We cannot be certain that:

we will be able to develop and validate any test that meets our desired target product profile and with the sensitivity and specificity necessary to address the relevant clinical need or commercial opportunity;

we will be able to obtain necessary regulatory authorizations in a timely manner or at all;

we will be able to develop the sales and marketing operations or enter into collaborative arrangements to achieve market awareness and demand;

we and our laboratory partners and licensees will successfully market, or healthcare providers will order or use, or third-party payers will reimburse (and if so, to what extent), any tests that we may enhance or develop;

any tests that we may enhance or develop can be provided at acceptable cost and with appropriate quality;

our current or future competitors will not introduce tests that have superior performance, lower prices or other characteristics that cause physicians to recommend, and consumers to choose, such competitive tests over our enhanced or newly-developed tests; or

our tests will not infringe patents held by third parties in key jurisdictions.

These and other factors beyond our control could result in delays in the research and development, approval, production, launch, marketing or distribution of enhanced or new tests could adversely affect our competitive position and results of operations.

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Our quarterly results may fluctuate significantly, which could adversely impact the value of our common stock.

Our quarterly results of operations, including our revenues, gross margin, profitability and cash flows, may vary significantly in the future, and period-to-period comparisons of our operating results may not be meaningful. Accordingly, our quarterly results should not be relied upon as an indication of future performance. Our quarterly financial results may fluctuate as a result of a variety of factors, many of which are outside of our control. Factors that may cause fluctuations in our quarterly financial results include, without limitation, those listed elsewhere in this "Risk Factors" section. In addition, our quarterly results may fluctuate due to the fact that we recognize costs as they are incurred, but there is typically a delay in the related revenue recognition as we record most revenue only upon receipt of payment. Accordingly, to the extent sales increase, we may experience increased losses unless and until the related revenues are recognized. In addition, as we continue to ramp up our internal sales and marketing and research and development efforts, we expect to incur costs in advance of achieving the anticipated benefits of such efforts. As we continue to increase utilization of our cloud-based distribution model by additional laboratory licensees, we may experience decreased revenues or slower revenue growth as the cost per test will be lower than for our laboratory-based model. Fluctuations in quarterly results may adversely impact the value of our common stock. We may also face competitive pricing or reimbursement pressures, and we may not be able to maintain our premium pricing in the future, which would adversely affect our operating results.

If we are unable to compete successfully with either existing or future prenatal testing products or other test methods, we may be unable to increase or sustain our revenues or achieve profitability.

We are in the molecular testing field, which is characterized by rapid technological changes, frequent new product introductions, changing customer preferences, emerging competition, evolving industry standards, and price competition. Our principal competition comes from existing testing methods, technologies and products, including other NIPTs and carrier screening tests offered by our competitors, used by obstetricians and gynecologists, or OB/GYNs, maternal fetal medicine, or MFM, specialists or in vitro fertilization, or IVF, centers. Established, traditional first-line prenatal screening methods, such as serum protein measurement, where doctors measure certain hormones in the blood, and invasive prenatal diagnostic tests like amniocentesis, have been used for many years and are therefore difficult to change or supplement. Moreover, many companies in our markets are offering, or may offer, products and services that compete with our tests, in some cases at a lower cost than ours. We cannot assure you that research and discoveries by other companies will not render our existing or potential tests uneconomical or result in tests superior to our existing tests and those we develop. We also cannot assure you that any of our existing tests or tests that we develop will be preferred by patients, physicians or payers to any existing or newly developed technologies or tests.

We compete with numerous companies in the genetic diagnostics space. Our competitors in NIPT include Sequenom, Inc., which was recently acquired by Laboratory Corporation of America Holdings, or LabCorp; Illumina, Inc., or Illumina, through its Verinata division; Ariosa, Inc., which was acquired by F. Hoffman La-Roche Ltd in 2014; Counsyl, Inc.; Quest Diagnostics Incorporated, or Quest; Premaitha Health PLC; BGI; Berry Genomics Co., Ltd.; Progenity, Inc., or Progenity; LifeCodexx AG; Synlab International GmbH; and Multiplicom N.V. All of our main NIPT competitors in the United States are owned or controlled by companies much larger than ours and with much greater resources for sales, marketing and research and development efforts. Our competitors in carrier screening include LabCorp; Counsyl, Inc.; Good Start Genetics, Inc.; Progenity; Quest; Recombine Inc.; NxGen MDx LLC; and GenPath Diagnostics, which is a business unit of OPKO Health, Inc. In addition, our future products, such as products in the field of cancer, will face competition from various companies that offer or seek to offer competing solutions. For example, Guardant Health, Inc., Personal Genome Diagnostics, Inc., Foundation Medicine, Inc. and Genomic Health Inc. have already developed and are offering commercially in the United States so-called liquid biopsy tests, which are clinical cancer diagnostic tests that examine blood samples, rather than solid tumor biopsies, and which are the type of cancer diagnostic tests that we are seeking to develop; Genomic Health Inc. has also announced plans to commercialize Epic Sciences’ liquid biopsy test in the United States. Many other companies, including much larger companies than ours, have announced that they are developing and seeking to commercialize liquid biopsy tests. Our planned cancer products are in very early stages of research and development, and we expect that the number of competitors in this space will continue to increase as we conduct our development and commercialization activities.

Some of our competitors’ products are sold at a lower price than our products. Tests and services being offered or developed by these and other companies could cause sales of our tests and services to decline or force us to reduce our

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prices. Our current and future competitors could have greater technological, financial, reputational and market access advantages than us, and we may not be able to compete effectively against them. Increased competition is likely to result in pricing pressures, which could harm our revenues, operating income or market share. If we are unable to compete successfully, we may be unable to increase or sustain our revenues or achieve profitability.

Our cloud-based distribution model may be difficult to implement.

We have only recently begun to deploy our bioinformatics technology for use by other laboratories by making it available through a cloud-based distribution model. This model relies on clinical laboratories in the United States and around the world taking a license from us under which the laboratory develops and runs its own NIPT based on Panorama or other molecular testing assays based on our technology in its own facilities and then accesses our proprietary algorithms through our cloud-based Constellation software for the analysis of the assay results. In the diagnostics industry, the market for cloud-based solutions and services is not as mature as the market for on-premise enterprise software, and it is uncertain how quickly and to what extent our cloud-based distribution model will achieve and sustain high levels of customer demand and market acceptance.

Deploying this new cloud-based distribution model involves risks, significant costs and potential liabilities and is dependent upon the skills, experience and efforts of our management and other employees and our relationship with, and efforts of, our licensees. We do not know whether we can build or support this model to scale. Among the risks to our business and results of operations are the following:

our ability to execute the strategy in a timely or efficient manner or at all;

our and our licensees' ability to obtain required regulatory authorizations from the FDA and international regulatory agencies;

supply constraints, including with respect to the sequencers and reagents that are required by our licensees to implement our technology and that are supplied by Illumina, Inc., one of our main competitors through its Verinata division, and the blood collection tubes that are used for our Panorama test and that are supplied by Streck, Inc., as further described in the risk factors entitled “—We rely on a limited number of suppliers or, in some cases, single suppliers, for some of our laboratory instruments and materials and may not be able to find replacements or immediately transition to alternative suppliers” and “Reimbursement and Regulatory Risks Related to Our Business—Failure to obtain necessary regulatory approvals in foreign jurisdictions may adversely affect our ability to expand our operations internationally”

potential third-party claims that the tests, based on our technology, developed by our licensees violate such third parties’ intellectual property rights in the territories in which our licensees commercialize their tests;

disruption of our business and distraction of our employees and management;

licensing portions of our proprietary technology to third parties that may not take the same security precautions as we do to protect this information; and

an inability to achieve anticipated benefits and costs savings.

We do not know whether clinical laboratories will adopt this method of using our products and services in sufficient volume. As of November 1, 2016, we have signed agreements with only 22 licensees under our cloud-based distribution model, and we have only been recognizing revenue under our cloud-based distribution model for NIPT for three full quarters. Only seven of our licensees have commercially launched an NIPT product using Constellation, and one licensee is currently using Constellation commercially to market its non-invasive prenatal paternity test in the United States and internationally. Other licensees for our cloud-based model are in earlier stages of development and still other potential licensees are in the contract negotiation stage. The rate of adoption of our cloud-based distribution model will depend on a number of factors, including the cost, performance and perceived value associated with our solution, as well as our ability to address security, privacy and regulatory requirements or concerns. In addition, our cloud-based software will need to be compatible with whatever next-generation sequencing, or NGS, hardware a clinical laboratory is using.

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Because we do not control the manufacturing and specifications of the NGS equipment, some clinical laboratories may not be able to use Constellation.

If we or other cloud-based solution providers experience security incidents, loss of customer data or disruptions in delivery or other problems, the market for cloud-based solutions in the diagnostics industry, including our solutions, may be adversely affected. Such events could also result in potential lawsuits and liability claims, which could have a material adverse effect on our business. If there is a reduction in demand for cloud-based solutions caused by technological challenges, weakening economic conditions, security or privacy concerns, competing technologies and products, decreases in corporate spending or other challenges, we may not be able to execute our planned business model, and our results of operations may be adversely affected.

We cannot assure you that we will be able to successfully implement the cloud-based distribution model or that implementation will result in benefits or cost savings at the levels that we anticipate or at all.

We may be unable to commercialize our cloud-based distribution model if we do not comply with ongoing FDA regulatory requirements, including if we are required to obtain FDA clearance to market our software for diagnostic purposes.

We utilize our Constellation software to aid in the calculation of test data. Laboratories utilizing our technology will have access to this software in our cloud-based distribution model. We have achieved a CE Mark from the European Commission for our Constellation software as well as for the key reagents that our laboratory licensees need to run their portion of the Panorama test prior to accessing our algorithms through Constellation, which enables us to offer Constellation for Panorama NIPT in the European Union and other countries that accept a CE Mark. It is possible that we will need to obtain regulatory clearance in the United States and elsewhere for our Constellation software in order for it to be used by third parties in the conduct of their diagnostic tests based on our technology. We are currently engaged in discussions with the FDA regarding the regulatory status of our Constellation software to make calls of copy number variants, which could be used to support our cloud-based distribution model for NIPT in the United States. The FDA has indicated to us that our Constellation software may be appropriate for review under the de novo classification process. However, the FDA has not committed to this position and may take a different position in the future. The FDA has stated that it will not prevent us from marketing Constellation in the United States while we continue to discuss with the FDA how it will be regulated; however, it is possible that the FDA may reverse itself on the issue of our ability to continue to market Constellation during our discussions. The FDA's decision about the appropriate pathway could also be impacted by its plans to regulate laboratory developed tests, or LDTs, which are tests that are designed, developed, validated and used within a single laboratory, as outlined in the October 3, 2014 draft guidance described in the risk factor entitled "Reimbursement and Regulatory Risks Related to Our Business—If the FDA were to begin actively regulating our tests as outlined in the FDA's October 3, 2014 draft guidance, we could incur substantial costs and delays associated with trying to obtain premarket clearance or approval and incur costs associated with complying with post-market controls." If necessary, we intend to seek regulatory clearance for our Constellation software; however, we cannot guarantee that we will obtain clearance. If clearance is required and we are unable to obtain it, we would be unable to commercialize our cloud-based distribution model in the United States.

If our Constellation software requires regulatory clearance, we will be subject to ongoing FDA obligations and continued regulatory oversight and review, including compliance with requirements such as the quality system regulation, or QSR, which establishes extensive requirements for quality assurance and control as well as manufacturing procedures; the listing of our devices with the FDA; adverse event and malfunction reporting; corrections and removals reporting; and labeling and promotional requirements. 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 offer Constellation and may be subject to enforcement action by the FDA, such as the issuance of warning or untitled letters, fines, injunctions and civil penalties; recall or seizure of products; operating restrictions and criminal prosecution. In addition, if a test developed by any of our licensees using our cloud-based distribution model in the United States is found not to be an LDT, or that licensee has difficulty obtaining the reagents and sequencing equipment for any regulatory, supply chain, or other reason, the licensee may not be able to market its test, and we would not receive the anticipated revenues from that licensee.

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Implementation of our cloud-based distribution model may negatively impact our financial results and results of operations.

Under our cloud-based distribution model, third party laboratories perform the molecular biology analysis in their own laboratories and access our bioinformatics algorithms in the cloud through our Constellation software to analyze their results. Although we receive license fees for use of our bioinformatics technology, because we do not process these tests and perform the molecular biology analysis in our laboratory, we are not able to charge as high an amount per test as when we perform the entire test ourselves, and our revenues per test are therefore lower than the amount we receive when we perform the entire test ourselves. If the lower revenues per test performed under our cloud-based distribution model is not offset by a sufficient increase in volume of tests sold or by the reduction in costs from not performing the entire test, our overall revenues will be lower, and our results of operations may be adversely affected. Additionally, to the extent that any of our laboratory customers for whom we perform our tests entirely in our laboratory transition to our cloud-based distribution model, our revenues from such customers will decrease, which may adversely affect our results of operations.

We may be subject to increased compliance risks as a result of our rapid growth, including our increased growth in and dependence on our direct sales force.

The percentage of our revenues attributable to our U.S. direct sales for the three months ended September 30, 2016 was 81%, up from 76% for the three months ended September 30, 2015. Prior to 2016, we experienced rapid growth in our U.S.-based internal sales force, and in our billing and marketing personnel, which has required us to expand our training and compliance efforts in line with the increase in new personnel in these functions. We have taken and continue to take steps to implement appropriate monitoring of our sales, billing, marketing and other personnel; however, we have in the past experienced, and we cannot assure you that we will not in the future experience, situations in which employees fail to strictly adhere to our policies. To the extent that there is any failure, whether actual or perceived, by our employees to follow our policies, we may incur additional training and compliance costs, or may receive inquiries from third-party payers or other third parties, or be held liable or otherwise responsible for such acts of non-compliance. Any of the foregoing could adversely affect our cash flow and financial condition.

We rely on internal and third-party data centers to host our laboratory and cloud-based software, and any interruptions of service or failures may impair the operations of our laboratory or the delivery of our cloud-based software and harm our business.

We currently maintain a data center at our laboratory facilities in San Carlos, California. We also currently provide and will continue to provide our cloud-based Constellation software to our laboratory licensees through third-party data center hosting facilities located in the United States. Any technical problems that may arise in connection with our on-site data center or with the third-party data center hosting facilities could result in interruptions in our laboratory operations or our cloud-based services. These types of problems may be caused by a variety of factors, including infrastructure changes, human or software errors, viruses, security attacks, fraud, spikes in customer usage and denial of service issues. Interruptions in our operations or service may reduce our revenue, cause us to issue refunds, cause laboratory licensees to terminate their contracts with us, or adversely affect our ability to attract new laboratory licensees. We could also be exposed to potential lawsuits and liability claims. Our business will also be harmed if our current or potential laboratory licensees believe our service is unreliable.

If our products do not perform as expected, our operating results, reputation and business will suffer.

Our success depends on the market's confidence that we can provide reliable, high-quality genetic testing results. There is no guarantee that the accuracy and reproducibility we have demonstrated to date will continue as our test volume increases and the types of tests we offer expands. We believe that our customers are likely to be particularly sensitive to test limitations and errors, including inaccurate test results and the need on occasion to perform second blood draws on patients. As a result, if our tests do not perform as expected, our operating results, reputation, and business will suffer. We may be subject to legal claims arising from such limitations, errors, or inaccuracies.

Panorama and our other products use a number of complex and sophisticated biochemical and bioinformatics processes, many of which are highly sensitive to external factors. An operational or technological failure in one of these

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complex processes or fluctuations in external variables may result in sensitivity and specificity rates that are lower than we anticipate or that vary between test runs, or in a higher than anticipated number of tests which fail to produce results. In addition, we regularly evaluate and refine our testing process. These refinements may result in unanticipated issues that may reduce our sensitivity and specificity rates.

We rely on third-party laboratories to perform some of our testing.

We and our subsidiaries outsource the portions of testing that we do not perform in-house to third-party CLIA laboratories. A significant portion of our Horizon carrier screening testing is performed by third-party laboratories. These third-party laboratories are subject to contractual obligations to perform this testing for us, but are not otherwise under our control. We therefore do not control the capacity and quality control efforts of these third-party laboratories other than through our ability to enforce contractual obligations on volume and quality systems, and we have no control over such laboratories’ compliance with applicable legal and regulatory requirements. We also have no control over the timeliness of such laboratories’ performance of their obligations to us, and the third-party laboratories that we contract with have had issues with delivering results to us within the time frames we expect or established in our contracts with them. In the event of any adverse developments with these third-party laboratories or their ability to perform this testing in a timely manner and in accordance with the standards that we and our customers expect, our ability to provide our Horizon test to customers may be delayed or interrupted, which could result in a loss of customers and harm to our reputation. Although we have more than one third-party laboratory performing this testing in order to avoid single sourcing, we may not have sufficient alternative backup if one or more of the third-party laboratories are unable to satisfy our demand for this testing with sufficient performance, quality and timeliness. Any natural or other disaster, acts of war or terrorism, shipping embargoes, labor unrest or political instability or similar events at one or more of our third-party laboratories' facilities that causes a loss of testing capacity would heighten the risks that we face. Changes to or termination of our agreements or inability to renew our agreements with these third-party laboratories or enter into new agreements with other laboratories that are able to perform such testing could impair, delay or suspend our efforts to market and sell the Horizon carrier screening test. In addition, certain third-party payers, including some state Medicaid payers, that we are under contract with may take the position that sending out this testing to third-party laboratories and billing for such tests is contrary to the terms of our contract and may refuse to pay us for the testing. If any of these events occur, our business, financial condition and results of operations could suffer. Further, some state laws impose anti-markup restrictions that prevent an entity from realizing a profit margin on outsourced testing. If we or our subsidiaries are unable to markup outsourced testing, our revenues and operating margins would suffer.

If we are unable to successfully grow revenues for our products in addition to Panorama, our business and results of operations may be adversely affected.

Our ability to successfully grow revenues for our products in addition to Panorama, such as Horizon, Spectrum, and Anora, is uncertain and is subject to risks. For example, the adoption and demand for such products may not grow as we expect; we may not be able to demonstrate that our products are equivalent to or superior to competing products; we and our laboratory partners may not be able to maintain and grow effective sales and marketing capabilities; our laboratory partners may choose to more actively or exclusively market tests by competitors; we may experience supply constraints; and we may fail to adequately protect our intellectual property relating to our products or others may claim we infringe their intellectual property rights. If we are not able to increase adoption of and grow revenues for these products, our business and results of operations may be adversely affected.

If the results of our clinical studies do not support the use of our tests, particularly in the average-risk pregnancy population or for microdeletions screening, or cannot be replicated in later studies required for regulatory approvals or clearances, our business, financial condition, results of operations and reputation could be adversely affected.

As the healthcare reimbursement system in the United States evolves to place greater emphasis on comparative effectiveness and outcomes data, we cannot predict whether we will have sufficient data, or whether the data we have will be presented to the satisfaction of any payers seeking such data in the process of determining coverage for our tests, particularly in the average-risk pregnancy population and for microdeletions screening using our Panorama test, for both of which such data is expected to be of particular interest.

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The publication of clinical data in peer-reviewed journals is a crucial step in commercializing and obtaining reimbursement for tests such as ours, and our inability to control when, if ever, results are published may delay or limit our ability to derive sufficient revenues from any test that is the subject of a study. Peer-reviewed publications regarding our tests may be limited by many factors, including delays in the completion of, poor design of, or lack of compelling data from, clinical studies, as well as delays in the review, acceptance and publication process. If our tests or the technology underlying our current tests or future tests do not receive sufficient favorable exposure in peer-reviewed publications, the rate of clinician adoption of our tests and positive reimbursement coverage determinations for our tests could be negatively affected.

The administration of clinical and economic utility studies, which are becoming more critical to commercial success of products like ours, is expensive and demands significant attention from certain members of our management team. Even if we are able to conduct such studies, the data collected from these studies may not be favorable or consistent with our existing data, or may not be statistically significant or compelling to the medical community.

In addition, development of the data necessary to obtain regulatory clearance and approval of a test is time consuming and carries with it the risk of not yielding the desired results. The performance achieved in published studies may not be repeated in later studies that may be required to obtain FDA premarket clearance or approval. Limited results from earlier-stage verification studies may not predict results from studies in larger numbers of subjects drawn from more diverse populations over a longer period of time. Unfavorable results from ongoing preclinical and clinical studies could result in delays, modifications or abandonment of ongoing analytical or future clinical studies, or abandonment of a product development program, or may delay, limit or prevent regulatory approvals or clearances or commercialization of our product candidates.

If our sole CLIA-certified laboratory facility becomes inoperable, we will be unable to perform our tests and our business will be harmed.

We do not currently have redundant commercial laboratory facilities, other than third-party laboratories that we employ to perform a significant portion of our Horizon carrier screen testing. Our San Carlos, California laboratory facility is situated near active earthquake fault lines. Our facilities may be harmed or rendered inoperable (or samples could be damaged or destroyed) by natural or manmade disasters, including earthquakes, flooding, power outages and contamination, which may render it difficult or impossible for us to perform our tests for some period of time. The inability to perform our tests or the backlog of tests that could develop if our facility is inoperable for even a short period of time may result in the loss of customers or harm our reputation.

We rely on a limited number of suppliers or, in some cases, single suppliers, for some of our laboratory instruments and materials and may not be able to find replacements or immediately transition to alternative suppliers.

We have sourced and will continue to source components of our technology, including sequencers, reagents, tubes and other laboratory materials, from third parties. In particular, our sequencers, many of our reagents, and our blood collection tubes are sole sourced. For example, Illumina is currently the sole supplier of our sequencers and related reagents for Panorama, as well as for our development activities relating to transplant and oncology diagnostics, along with certain hardware and software, pursuant to a supply agreement that expires in June 2026. Without sequencers and the related reagents, we would be unable to run our tests and commercialize our products. In addition, all of the licensees under our cloud-based distribution model are also required to use Illumina sequencers and reagents to run the tests that they develop based on our technology. In early 2013, prior to our entering into our agreement with Illumina, Illumina completed its acquisition of Verinata Health Inc., or Verinata, our direct competitor in the NIPT market. We understand Illumina supplies the same or similar sequencers and consumables to Verinata, which is now a division of Illumina. Because of Illumina's acquisition of Verinata, we face increased risk and uncertainty regarding continuity of a successful working relationship with Illumina under the current supply agreement, including with respect to our ability to compete with Verinata in the marketplace based on test price and in view of economic advantages enjoyed by Verinata associated with the cost of sequencers and related consumables. Our failure to maintain a continued supply of the sequencers and reagents, along with the right to use certain hardware and software, would adversely impact our business, financial condition, and results of operations. In the event that it is in our commercial or financial interest or we are forced to transition sequencing platforms,

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we may not be successful in selecting, acquiring on commercially reasonable terms, and implementing an alternative platform that is satisfactory for our needs or that we can employ in a commercially sustainable way.

In addition, Streck, Inc., or Streck, is the sole supplier of the blood collection tubes included in our Panorama test. All of the licensees under our cloud-based distribution model are also required to use these blood collection tubes to run the tests that they develop based on our technology. The blood collection tubes supplied by Streck are intended for research use only and are labeled as RUO. Our sequencers, sourced from Illumina, as well as certain other reagents we use for Panorama and our other tests, are also labeled as RUO. As discussed further in the risk factor entitled “Reimbursement and Regulatory Risks Related to Our Business—Changes in the way the FDA regulates the reagents, other consumables, and testing equipment we use when developing, validating, and performing our tests could result in delay or additional expense in bringing our tests to market or performing such tests for our customers,” the FDA may determine that a product labeled RUO is intended to be used diagnostically, and could take enforcement action against the supplier of the product. If this were to occur with respect to Streck, Illumina or any of our other suppliers of RUO products, we would be required to obtain one or more alternative sources of these products, and we may not be able to do so on commercially reasonable terms or at all. Furthermore, because our licensees under our cloud-based distribution model are also required to use such sole-sourced components to run the tests they develop based on our technology, and our laboratory distribution partners are required to use certain of such sole-sourced components in order to utilize our tests, any enforcement action against the supplier by the FDA or any other regulatory authority in the jurisdictions in which our licensees and laboratory distribution partners are located could have an adverse impact on our business.

Our failure to maintain a continued supply of components, or a supply that meets quality control requirements, particularly in the case of sole suppliers, would materially and adversely harm our business, financial condition, and results of operations. Changes to or termination of our agreements or inability to renew our agreements with these parties or enter into new agreements with other suppliers could result in the loss of access to important components of our tests and could impair, delay or suspend our commercialization efforts, including efforts to market and commercialize Panorama. In the event of any adverse developments with our sole suppliers, our ability to supply our products may be interrupted, and obtaining substitute components could be difficult or require us to re-design our products or, for any products for which we may obtain approval from the FDA, obtain approval from the FDA to use a new supplier. In addition, if we obtain a premarket approval, or PMA, for Panorama, such issues with suppliers or the components that we source from suppliers could affect our commercialization efforts, as further described in the risk factor entitled “Reimbursement and Regulatory Risks Related to Our Business—If the FDA were to begin actively regulating our tests as outlined in the FDA's October 3, 2014 draft guidance, we could incur substantial costs and delays associated with trying to obtain premarket clearance or approval and incur costs associated with complying with post-market controls.” Transitioning to a new supplier from any of our sole suppliers could be time consuming and expensive, may result in interruptions in our ability to supply our products to the market, could affect the performance specifications of our tests or could require that we re-validate Panorama and our other tests using replacement equipment and supplies, which could delay the performance of our tests and result in increased costs.

Because we rely on third-party manufacturers, we do not control the manufacture of these components, including whether such components will meet quality control requirements. If the supply of components we receive do not meet quality control standards, we may not be able to use the components, or if we use them not knowing that they are of inadequate quality, which has in the past occurred with respect to certain reagents, our tests may not work properly or at all. Because we cannot ensure the actual production or manufacture of such critical equipment and materials, or the quality of such components, or the ability of our suppliers to comply with applicable legal and regulatory requirements, we may be subject to significant delays caused by interruption in production or manufacturing or to lost revenue from such interruption or from spoiled tests. In addition, any natural or other disaster, acts of war or terrorism, shipping embargoes, labor unrest or political instability or similar events at our third-party manufacturers' facilities that causes a loss of manufacturing capacity would heighten the risks that we face.

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If our laboratory partners do not effectively market or sell, or decide to stop selling, our products, and we are not able to offset the resulting impact to our gross profit through our direct sales efforts or through agreements with new partners, our commercialization activities may be impaired and our financial results could be adversely affected.

While we have expanded our U.S. direct sales force to increase our direct sales, a significant element of our commercial strategy remains to establish and leverage relationships with our laboratory partners to sell Panorama and our other products, both in the United States and internationally. Distributing Panorama and our other products through partners reduces our control over our revenues, our market penetration and our gross margin on sales by the partner if we could have otherwise made that sale through our direct sales force. The financial condition of these laboratories could weaken, these laboratory partners could stop selling our products, reduce their marketing efforts in respect of our products, or otherwise breach their agreements with us. Furthermore, our laboratory partners may misappropriate our trade secrets or use our proprietary information in such a way as to expose us to litigation and potential liability. Disagreements or disputes with our laboratory partners, including disagreements over customers, proprietary rights or our or their compliance with contractual obligations, might cause delays or impair the commercialization of Panorama or our other tests, lead to additional responsibilities for us with respect to new tests, or result in litigation or arbitration, any of which would divert management attention and resources and be time consuming and expensive.

In addition, we face the risk of our laboratory partners terminating their relationship with us and completely suspending the sale of our products, which occurred in 2014 with both Quest and Progenity, who were our two largest laboratory partners in 2013. Other laboratory partners may decide to exercise their termination rights under our contracts, or any laboratory partner that is not bound by obligations of exclusivity or non-competition to us or our products could decide to sell a competing product and may choose to promote such tests in addition to or in lieu of our tests. Moreover, our partners could merge with or be acquired by a competitor of ours or a company that chooses to de-prioritize the efforts to sell our products. For example, Bio-Reference was acquired by OPKO Health, Inc., and we cannot assure you that this acquisition will not impact, or cause termination of, our agreement with Bio-Reference.

If our partnerships are not successful, our ability to increase sales of Panorama and our other products and to successfully execute our strategy could be compromised.

We rely on commercial courier delivery services to transport samples to our laboratory facility in a timely and cost-efficient manner and if these delivery services are disrupted, our business will be harmed.

Our business depends on our ability to quickly and reliably deliver test results to our customers. We typically receive blood samples for analysis at our San Carlos, California facility within days of collection from the patient. Disruptions in delivery service, whether due to labor disruptions, bad weather, natural disaster, terrorist acts or threats or for other reasons could adversely affect specimen integrity, our ability to process samples in a timely manner and to service our customers, and ultimately our reputation and our business. In addition, if we are unable to continue to obtain expedited delivery services on commercially reasonable terms, our operating results may be adversely affected.

Security breaches, loss of data and other disruptions, including with respect to cybersecurity, could compromise sensitive information related to our business or prevent us from accessing critical information and expose us to liability, which could adversely affect our business and reputation.

In the ordinary course of our business, we collect and store sensitive data, including legally-protected health information, such as Panorama results, credit card and other financial information, insurance information, and personally identifiable information. We also store sensitive intellectual property and other proprietary business information, including that of our customers, payers and collaboration partners. We manage and maintain our applications and data utilizing a combination of on-site systems, managed data center systems and cloud-based data center systems. These applications and data encompass a wide variety of business critical information, including research and development information, commercial information and business and financial information. We are highly dependent on information technology networks and systems, including the Internet, to securely process, transmit, and store this critical information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure, and that of our third-party billing and collections provider and other technology partners, may be vulnerable to cyber-attacks by hackers or viruses or breached due to employee error, malfeasance or other disruptions.

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Any such breach or interruption could compromise our data security, and the information we store could be inaccessible by us or could be accessed by unauthorized parties, publicly disclosed, lost or stolen. Any such interruption in access, improper access, disclosure, modification, or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and regulatory penalties. We may be required to comply with state breach notification laws, become subject to mandatory corrective action, or be required to verify the correctness of database contents. Unauthorized access, loss or dissemination could also disrupt our operations, including our ability to perform tests, provide test results, bill payers or patients, process claims and appeals, provide customer assistance services, conduct research and development activities, develop and commercialize tests, collect, process and prepare company financial information, provide information about our tests, educate patients and clinicians about our service, and manage the administrative aspects of our business, any of which could damage our reputation and adversely affect our business. In addition, these breaches and other inappropriate access can be difficult to detect, and any delay in identifying them may compound these adverse consequences. Any such breach could also result in the compromise of our trade secrets and other proprietary information, which could adversely affect our competitive position.

Our cloud-based distribution model adds additional data privacy risk, as certain personal health and other information may be sent to and stored in the cloud by our laboratory licensees. We have contractually obligated our partners to not send personally-identifiable information to our cloud servers, and we have an agreement with the vendor that hosts our software in the cloud to comply with data privacy laws, such as HIPAA. However, we cannot be certain that our partners will comply with these requirements or that our cloud vendor will comply with the terms of our agreement.

In addition, the interpretation and application of health-related, privacy and data protection laws in the United States, Europe, and elsewhere are often uncertain, contradictory and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. If so, this could result in government-imposed fines or orders requiring that we change our practices, which could adversely affect our business and our reputation. Complying with these laws could cause us to incur substantial costs or require us to change our business practices and compliance procedures in a manner adverse to our business.

The marketing, sale, and use of Panorama and our other products could result in substantial damages arising from product liability or professional liability claims that exceed our resources.

The marketing, sale and use of Panorama and our other products could lead to product liability claims against us if someone were to allege that our test failed to perform as it was designed, was performed pursuant to incorrect or inadequate laboratory procedures, if we delivered incorrect or incomplete test results, or if someone were to misinterpret test results. In addition, we may be subject to liability for errors in, a misunderstanding of, or inappropriate reliance upon, the information we provide, or failure to provide such information, as part of the results generated by Panorama and our other products. For example, Panorama could provide a low-risk result which a patient or physician may rely upon to make a conclusion about the health of the fetus, which may, in fact, have the condition because the Panorama result was a so-called false negative. If the resulting baby is born with the condition, the family may file a lawsuit against us claiming product or professional liability. We are currently involved in a lawsuit by a patient alleging that we failed to perform a test that was ordered. See Part II, Item 1—Legal Proceedings. A product liability or professional liability claim could result in substantial damages and be costly and time-consuming for us to defend. Although we maintain product and professional liability insurance, our insurance may not fully protect us from the financial impact of defending against product liability or professional liability claims or any judgments, fines or settlement costs arising out of any such claims. Any product liability or professional liability claim brought against us, with or without merit, could increase our insurance rates, cause our insurance coverage to be terminated or prevent us from securing insurance coverage in the future. Additionally, any product liability or professional liability lawsuit could harm our reputation, result in a cessation of our services or cause our partners to terminate our agreements with them, any of which could adversely impact our results of operations.

If we are unable to successfully scale our operations, our business could suffer.

As our test volumes grow, we will need to continue to ramp up our testing capacity, implement increases in scale and related processing, office space, customer service, billing and systems process improvements and expand our internal quality assurance program and technology platform. We will also need additional equipment, laboratory space and certified

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laboratory personnel to process higher volumes of our tests. As additional tests are developed, we may need to bring new equipment on-line, implement new systems, technology, controls and procedures, and hire personnel with different qualifications. The value of Panorama and our other products depends, in part, on our ability to perform the tests on a timely basis and at an exceptionally high standard of quality, and on our reputation for such timeliness and quality. Failure to implement necessary procedures, transition to new equipment or processes or to hire the necessary personnel in a timely and effective manner could result in higher processing costs or an inability to meet market demand. We cannot assure you that our efforts to scale our commercial operations will not negatively affect the quality of our test process or results, or that we will be successful in managing the growing complexity of our testing operations.

In particular, to execute our growth plan, we must attract and retain highly qualified personnel. Competition for these personnel is intense, especially for sales, scientific, medical, laboratory and technical personnel and especially in the San Francisco Bay Area where our headquarters and laboratory facility is located, and the turnover rate can be high. We have from time to time experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees or we have breached their legal obligations to their former employers, resulting in a diversion of our time and resources. In addition, job candidates and existing employees in the San Francisco Bay Area often consider the value of the equity awards they receive in connection with their employment. If the perceived value of our equity awards declines, it may adversely affect our ability to recruit and retain highly skilled employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be adversely affected.

In addition, our growth may place a significant strain on our management, operating and financial systems and our sales, marketing and administrative resources. As a result of our growth, our operating costs may escalate even faster than planned, we may face difficulties in obtaining additional office or laboratory space, and some of our internal systems may need to be enhanced or replaced. If we cannot effectively manage our expanding operations and our costs, we may not be able to grow successfully or we may grow at a slower pace, and our business could be adversely affected.

Our financial condition and results of operations may be adversely affected by international government regulatory and business risks.

As we expand our international operations and offer our tests in other countries, we will be increasingly subject to varied and complex foreign and international laws and regulations. Compliance with these laws and regulations often involves significant costs and may require changes in our business practices that may result in reduced revenues and profitability.

We are subject to the Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, which prohibits companies and their intermediaries from making payments in violation of law to non-U.S. government officials for the purpose of obtaining or retaining business or securing any other improper advantage. Our reliance on independent laboratories to sell Panorama and other products internationally demands a high degree of vigilance in maintaining our policy against participation in corrupt activity, because these distributors could be deemed to be our agents, and we could be held responsible for their actions. Other U.S. companies in the medical device and pharmaceutical field have faced criminal penalties under the FCPA for allowing their agents to deviate from appropriate practices in doing business with foreign government officials. We are also subject to similar anti-bribery laws in the jurisdictions in which we operate, including the United Kingdom's Bribery Act of 2010, which also prohibits commercial bribery and makes it a crime for companies to fail to prevent bribery. These laws are complex and far-reaching in nature. Any violations of these laws, or allegations of such violations, could disrupt our operations, involve significant management distraction, involve significant costs and expenses, including legal fees, and could result in a material adverse effect on our business, prospects, financial condition, or results of operations. We could also suffer severe penalties, including criminal and civil penalties, disgorgement, and other remedial measures.

In addition, our international activities are subject to U.S. economic and trade sanctions, which restrict or otherwise limit our ability to do business in certain designated countries. Other limitations, such as prohibitions on the import into the United States of tissue necessary for us to perform our tests or restrictions on the export of tissue or genetic

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data imposed by countries outside of the United States, or restrictions on importation and circulation of blood collection tubes or other equipment or supplies by countries outside the United States, may limit our ability to offer our tests internationally in the future. We may also face competition from companies located in the countries in which we or our partners offer our tests, and in which we may be at a competitive disadvantage because the country may favor a local provider or for other reasons.

By operating internationally, we may experience longer accounts receivable payment cycles and difficulties in collecting accounts receivable; realize lower margins due to lower pricing in many countries; incur potentially adverse tax consequences, including the complexities of foreign value added tax systems, tax inefficiencies related to our corporate structure and restrictions on the repatriation of earnings; experience financial accounting and reporting burdens and complexities; be subject to trade barriers such as tariffs, quotas, preferential bidding or import or export licensing requirements; be exposed to political, social and economic instability abroad, including terrorist attacks and security concerns; be exposed to fluctuations in currency exchange rates; and enjoy reduced or varied protection for intellectual property rights.

Outside the United States we enlist local and regional laboratories and other service providers to assist with blood draw, engineering, sales, marketing and customer support. Subject to regulatory clearance, where required, we also contract with international licensees to run the molecular portion of our tests in their own labs and then access our algorithm for analysis of the resulting data through our cloud-based Constellation platform. Locating, qualifying and engaging additional distribution partners and local laboratories with local industry experience and knowledge will be necessary to effectively market and sell our tests outside the United States. We may not be successful in finding, attracting and retaining such distribution partners or laboratories, or we may not be able to enter into such arrangements on favorable terms. Sales practices utilized by our distribution partners that are locally acceptable may not comply with sales practice standards required under United States laws that apply to us, which could create additional compliance risk. Our training and compliance program and our other internal control policies and procedures may not always protect us from acts committed by our employees or agents. Non-compliance by us or our employees or agents of these or any other applicable laws or regulations could result in fines or penalties, or adversely affect our ability to operate and grow our business. Even if we are able to effectively manage our international operations, if our distribution partners and local and regional laboratory licensees are unable to effectively manage their businesses, our business and results of operations could be adversely affected. If our sales and marketing efforts are not successful outside the United States, we may not achieve market acceptance for our tests outside the United States, which would harm our business.

Operating internationally requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required to increase international revenues or expand our international presence will produce desired levels of revenues or profitability.

If we lose the services of our founder and Chief Executive Officer or other members of our senior management team, we may not be able to execute our business strategy.

Our success depends in large part upon the continued service of our senior management team. In particular, our founder and Chief Executive Officer, Matthew Rabinowitz, is critical to our vision, strategic direction, culture, products and technology. Although Dr. Rabinowitz spends significant time with us and is highly active in our management, he has the ability to spend up to one business day per week on other commitments pursuant to his employment agreement. In addition, we do not maintain key-man insurance for Dr. Rabinowitz or any other member of our senior management team. The loss of our founder and Chief Executive Officer or one or more other members of our senior management team could have an adverse effect on our business.

We may engage in acquisitions that could disrupt our business, cause dilution to our stockholders or reduce our financial resources.

In the future, we may enter into transactions to acquire other businesses, products or technologies. Because we have not made any acquisitions to date, our ability to do so successfully is unproven. Even if we identify suitable targets, we may not be able to make such acquisitions on favorable terms or at all. Any acquisitions we make may not strengthen our competitive position, and these transactions may be viewed negatively by customers or investors. We may decide to

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incur debt in connection with an acquisition or issue shares of our common stock or other equity securities to the stockholders of the acquired company, which would cause dilution to our existing stockholders. We could incur losses resulting from undiscovered liabilities of the acquired business that are not covered by any indemnification we may obtain from the seller. In addition, we may not be able to successfully integrate the acquired personnel, technologies and operations into our existing business in an effective, timely and non-disruptive manner. Acquisitions may also divert management attention from day-to-day responsibilities, increase our expenses and reduce our cash available for operations and other uses. We cannot predict the number, timing or size of future acquisitions or the effect that any such transactions might have on our operating results.

We may need to raise additional capital, and if we cannot do so when needed or on commercially acceptable terms, we may have to curtail or cease operations.

We may need to raise additional funds through public or private equity or debt financings, corporate collaborations or licensing arrangements to continue to fund or expand our operations.

Our actual liquidity and capital funding requirements will depend on numerous factors, including:

our ability to achieve broader commercial success with Panorama, Horizon and our other products;

the success of our research, development, and commercialization efforts for potential new products, including in the field of cancer;

our ability to obtain more extensive coverage and reimbursement for our tests, including in the average-risk patient population and for microdeletions screening;

our ability to generate sufficient revenues from our cloud-based distribution model;

our ability to collect our accounts receivable;

the costs and success of further expansion of our sales and marketing activities and research and development activities;

our need to finance capital expenditures and further expand our clinical laboratory operations;

our ability to manage our operating costs; and

the timing and results of any regulatory authorizations that we are required to obtain for our tests.

Additional capital, if needed, may not be available on satisfactory terms or at all. Furthermore, any additional capital raised through the sale of equity or equity-linked securities will dilute stockholders' ownership interests in us and may have an adverse effect on the price of our common stock. In addition, the terms of any financing may adversely affect stockholders' holdings or rights. Debt financing, if available, may include restrictive covenants. To the extent that we raise capital through collaborations and licensing arrangements, it may be necessary to relinquish some rights to our technologies or grant licenses on terms that may not be favorable to us.

If we are not able to obtain adequate funding when needed, we may have to delay development programs or sales and marketing initiatives. In addition, we may have to work with a partner on one or more of our tests or market development programs, which could lower the economic value of those programs to our company.

Our outstanding debt may impair our financial and operating flexibility.

As of September 30, 2016 and December 31, 2015, we had approximately $49.5 million and $42.1 million, respectively, of debt outstanding. Except for operating leases, we do not have any off-balance sheet financing arrangements in place or available.

Our ability to make principal and interest payments on our indebtedness will depend on our ability to generate cash in the future. We may incur additional indebtedness in the future. If we incur additional debt, a greater portion of our cash flows may be needed to satisfy our debt service obligations, and if we do not generate sufficient cash to meet our debt

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service requirements, we may need to seek additional financing. In that case, it may be more difficult, or we may be unable, to obtain financing on terms that are acceptable to us. As a result, we would be more vulnerable to general adverse economic, industry and capital markets conditions as well as the other risks associated with indebtedness. In addition, our debt agreements have in the past, and may in the future, contain various restrictive covenants and may be secured by some or all of our assets, including our intellectual property. These restrictions could limit our ability to use operating cash flow in other areas of our business because we must use a portion of these funds to make principal and interest payments on our debt.

Ethical, legal and social concerns related to the use of genetic information could reduce demand for our tests.

DNA testing, like that conducted using Panorama, Horizon and our other products and that we expect to conduct in the field of cancer, has raised ethical, legal and social issues regarding privacy and the appropriate uses of the resulting information. Governmental authorities could, for social or other purposes, limit or regulate the use of genomic information or genomic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, these concerns may lead patients to refuse to use genetic tests even if permissible. Ethical and social concerns may also influence U.S. and foreign patent offices and courts with regard to patent protection for technology relevant to our business. These and other ethical, legal and social concerns may limit market acceptance of our tests or reduce the potential markets for services and products enabled by our technology platform, either of which could harm our business.

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

Under Section 382 of the Internal Revenue Code of 1986, as amended, if a corporation undergoes an "ownership change" (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation's ability to use its pre-change net operating loss, or NOL, carryforwards and other pre-change tax attributes to offset its post-change income or taxes may be limited. As a result of our most recent private placements of equity securities and other transactions that have occurred over the past three years, or upon our recent initial public offering, we may have experienced an "ownership change." We may also experience ownership changes in the future as a result of subsequent shifts in our stock ownership (some of which may not be in our control). As of December 31, 2015, we had federal and state NOL carryforwards of approximately $114.5 million and $73.2 million, respectively, which begin to expire in 2027 and 2017, respectively, if not utilized. We also had federal research and development credit carryforwards of approximately $4.6 million, which begin to expire in 2027, and state research and development credit carryforwards of approximately $3.4 million, which can be carried forward indefinitely. Our ability to use these carryforwards could be limited if we experience "ownership changes."

Reimbursement and Regulatory Risks Related to Our Business

If we are unable to expand or maintain third-party payer coverage and reimbursement for Panorama and our other tests, or if we are required to refund any reimbursements already received, our revenues and results of operations would be adversely affected.

Our business depends on our ability to obtain or maintain adequate reimbursement coverage from third-party payers and patients. Third-party reimbursement for our testing represents a significant portion of our revenues, and we expect third-party payers such as insurance companies and government healthcare programs to be our most significant source of payments going forward. In particular, we believe that expanding insurance coverage from the high-risk to the average-risk pregnancy population, which represents roughly 80% of the United States pregnancy market, and for microdeletions screening, and obtaining positive coverage determinations and favorable reimbursement rates from commercial third-party payers and the Centers for Medicare & Medicaid Services, or CMS, and state reimbursement programs for Panorama, will be necessary to continue to achieve commercial success. If we are unable to obtain or maintain adequate reimbursement coverage from, or achieve in-network status with, third-party payers for our existing tests or future tests, our ability to generate revenues would be limited. For example, physicians may be reluctant to order our tests due to the potential of a substantial cost to the patient if reimbursement coverage is unavailable or insufficient.

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In making coverage determinations, third-party payers often rely on practice guidelines issued by professional societies. The American College of Medical Genetics, or ACMG, has recently issued updated guidelines recommending informing pregnant women that NIPT is the most sensitive screening option for Patau, Edwards and Down syndromes, as well as of the availability of the expanded use of NIPT to screen for clinically relevant copy number variants, or CNVs, in the context of counseling that includes the risks/benefits and limitations of screening for CNVs. A CNV is a genetic mutation in which a segment of the genome has been deleted or duplicated, including microdeletions in which a small segment of a chromosome is deleted. The International Society for Prenatal Diagnosis, or ISPD, has issued guidelines that are supportive of performing NIPT in average-risk pregnancies, as well as high-risk pregnancies. However, the American College of Obstetricians and Gynecologists, or ACOG, and the Society for Maternal Fetal Medicine, or SMFM, have issued guidelines for NIPT stating that, while all pregnant women should be informed of the option to receive NIPT, conventional screening methods, such as traditional serum screening, rather than NIPT, remain the most appropriate choice for first-line screening for average-risk pregnancies. While we expect that, based on the ACMG, ACOG and SMFM guidelines, more average-risk women will be informed of NIPT and may request it, it is uncertain whether third-party payers will reimburse for NIPT for these average-risk patients. Currently, most third-party payers have negative coverage determinations for average-risk patient populations, meaning that their policy is not to reimburse for NIPT for patients in the average-risk population. The ACOG and SMFM guidelines also echoed a previous statement from SMFM that routine screening for microdeletions should not be performed. Some third-party payers do not reimburse for microdeletions screening. While we recently published data on the performance of Panorama for the 22q11.2 deletion syndrome, ACOG and SMFM's advising against screening for microdeletions may continue to have a negative impact on third-party payers' reimbursement for Panorama for microdeletions, at least until additional validation data on the sensitivity and specificity of our tests becomes available. If we are unable to present satisfactory additional data on the performance of Panorama for 22q11.2 deletion syndrome, we may be unable to obtain positive coverage determinations for our test. If third-party payers do not reimburse for NIPT for average-risk pregnancies or microdeletions in the future, our future revenues and results of operations would be adversely affected.

The reimbursement environment, particularly for molecular diagnostics, is changing and our efforts to broaden reimbursement for our tests with third-party payers may not be successful. Third-party payers from whom we have received reimbursement may withdraw coverage or decrease the amount of reimbursement coverage for our tests at any time and for any reason. In some cases, our tests or their uses with certain populations, such as for microdeletions, may be considered experimental by third-party payers and, as a result, such payers may decide not to reimburse for such tests. In addition, third-party payers may decide to bundle payment for multiple tests, such as carrier screen tests, like Horizon, that screen for multiple conditions, or our Panorama test and the separate Panorama screen for microdeletions, into a single payment rate. Third-party payers may also decide to deny payment or recoup payment for testing that they determine to have been not medically necessary or otherwise against their coverage determinations, and we may be required to refund reimbursements already received. We have dealt with these types of requests for recoupment from third-party payers from time to time in the ordinary course of our business, and it is possible that we will continue to do so in the future.

Furthermore, some of our contracts with third-party payers contain so-called most favored nations provisions, pursuant to which we have agreed that we will not bill the third-party payer more than we bill any other third-party payer. We must therefore monitor our billing and claims submissions to ensure that we remain in compliance with these contractual requirements with third-party payers. If we do not successfully manage these most favored nations provisions, we may need to forego revenues from some third-party payers, which would adversely affect our revenues, and we may be subject to claims for recoupment, which could require the time and attention of our management, and may be a distraction from development of our business.

In addition, if a third-party payer denies coverage, it may be difficult for us to collect from the patient, and we may not be successful in doing so. Further, we are often unable to collect the full amount of a patient’s responsibility where we are an out-of-network provider and the patient is left with a large balance, despite our good faith efforts to collect. As a result, we cannot always collect the full amount due for our tests when third-party payers deny coverage, cover only a portion of the invoiced amount or the patient has a large deductible, which may cause payers to raise questions regarding our billing policies and patient collection practices. We believe that our billing policies and our patient collection practices are compliant with applicable laws and our obligations to these payers. However, we have in the past received, and we may in the future receive, inquiries from third-party payers regarding our billing policies and collection practices, and we have addressed these inquiries as and when they have arisen. There is no guarantee that we will always be

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successful in addressing such concerns, possibly resulting in a third-party payer deciding to reimburse for our tests at a lower rate or not at all, may seek recoupment of amounts previously paid to us, or may bring legal action seeking reimbursement of previous amounts paid, any of which could cause reimbursement revenue for our testing, which constitutes the large majority of our revenue, to decline. Furthermore, if a third-party payer were to be successful in proving such reimbursement was in breach of contract or otherwise contrary to law, we could be required to make a repayment, which could be significant, and we might be required to restate our financials from a prior period, which would likely cause our stock price to decline.

We are aware of policies and practices of our competitors to offer patients a set cap on their out-of-pocket responsibility, waive patient responsibility altogether, and, in some cases, to not send patients a bill at all, all of which we believe is not in accordance with third-party payers' policies and, in some cases, not compliant with the law. In contrast, it is our policy not to offer such caps or waivers and to send bills to patients for services rendered. Because of this discrepancy, our offerings may be perceived as less attractive to patients and their healthcare providers, who are concerned about patients having a large financial responsibility for these products. As a result, we believe that our revenues and results of operations have been adversely affected, and may continue to be so affected to the extent that our competitors continue such practices.

Our revenues may be adversely affected if we are unable to successfully obtain reimbursement from the Medicare Program.

Our revenues from Medicare are currently very small, given the population that Medicare covers, and we do not expect those revenues to increase materially with regard to NIPT. However, Medicare reimbursement can affect Medicaid reimbursement. For example, fee-for-service Medicaid programs generally do not reimburse at rates that exceed Medicare's fee-for-service rates and many commercial third-party payers look to the amounts that Medicare pays for testing services and set their payment rates at a percentage of those amounts. Reimbursement amounts for laboratory tests furnished to Medicare beneficiaries are typically based on the Clinical Laboratory Fee Schedule, or CLFS, set by CMS pursuant to a statutory formula established by the U.S. Congress. Our current Medicare Part B reimbursement was not set pursuant to a national coverage determination by CMS. Although we believe that coverage is available under Medicare Part B even without such a determination, we currently lack the national coverage certainty afforded by a formal coverage determination by CMS. Thus, CMS could issue an adverse coverage determination as to Panorama which could influence other third-party payers, including Medicaid, which could have an adverse effect on our revenues.

Our revenues may be adversely affected if we are unable to successfully obtain reimbursement from state Medicaid programs.

Approximately 40% of all births in the United States are to state Medicaid program recipients. Under Medicaid regulations, in order for us to be reimbursed by a state’s Medicaid program, we must be recognized as a Medicaid provider by the state in which the Medicaid recipient receiving the services resides. As of November 1, 2016, we are recognized by 39 states as a Medicaid provider. We may not be able to be recognized as a provider by many more Medicaid programs, because some states require that a provider maintain a laboratory in that state in order to be recognized; furthermore, some states have closed provider panels, which means that the state does not intend to expand its current provider network and therefore does not intend to recognize additional Medicaid providers. In addition, we have faced challenges in obtaining reimbursement even when we are recognized as a Medicaid provider, and we do not receive reimbursement in many of the states in which we are recognized. If Medicare’s CLFS rate for our services and tests are low, the Medicaid reimbursement amounts are sometimes as low, or lower, than the Medicare reimbursement rate. In some cases, the state Medicaid program’s reimbursement rate for our testing might be zero dollars. In addition, each state’s Medicaid program has its own coverage determinations related to our testing, and many state Medicaid programs do not provide their recipients with coverage for our testing. Low or zero dollar Medicaid reimbursement rates for our tests could have an adverse effect on our business and revenues.

Many Medicaid programs have entered into agreements with managed care plans to have the managed care plans manage the provision of healthcare to that Medicaid program’s beneficiaries. In order for us to enter into contracts to provide our testing services to beneficiaries who are enrolled with a Medicaid managed care plan, we must be recognized

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as a Medicaid provider in that state. Thus, not being able to participate in one or more managed Medicaid plans in a given state could have an adverse effect on our revenues.

Our revenues may be adversely impacted if third-party payers withdraw coverage or provide lower levels of reimbursement due to changing policies, billing complexities or other factors.

Some third-party payers from whom we have received reimbursement to date have not entered into agreements with us that govern approval or payment terms. Therefore, such third-party payers could withdraw such coverage and reimbursement for our tests in the future, at any time and for any reason. Managing reimbursement on a case-by-case basis is time consuming and contributes to an increase in the number of days it takes us to collect on accounts, and increases our risk of non-payment. Negotiating reimbursement on a case-by-case basis also typically results in the receipt of reimbursement at a significant discount to the list price of our tests.

Further, even if we are under contract with a third-party payer, the contract does not guarantee reimbursement for all testing we perform. For example, many third-party payers with whom we have written agreements typically have policies that state they will not reimburse for use of NIPTs in the average-risk pregnancy population or for the screening of microdeletions. In addition, the terms of certain of our agreements require us to seek prior authorization from the third-party payer, require a physician or qualified practitioner’s signature on test requisitions, or put in place other controls and procedures prior to conducting a test. To the extent we or the physicians ordering our tests do not follow these requirements, we may be subject to claims for recoupment of reimbursement amounts previously paid to us, or may not receive some or all of the reimbursement payments to which we would otherwise be entitled, which has occurred in some cases, which may have an adverse impact on our revenues.

Even if we are being reimbursed for our tests, third-party payers may review and adjust the rate of reimbursement, require co-payments from patients or stop paying for our tests. Government healthcare programs and other third-party payers continue to increase their efforts to control the cost, utilization and delivery of healthcare services by demanding price discounts or rebates and limiting coverage of, and amounts they will pay for, molecular diagnostic tests. These measures have resulted in reduced payment rates and decreased utilization for the clinical laboratory industry. Because of these cost-containment trends, governmental and commercial third-party payers that currently provide reimbursement for, or may in the future cover, our tests may reduce, suspend, revoke or discontinue payments or coverage at any time. Reduced reimbursement of our tests may harm our business, financial condition or results of operations.

Billing for clinical laboratory testing services is complex. We perform tests in advance of payment and without certainty as to the outcome of the billing process. In cases where we expect to receive a fixed fee per test due to our reimbursement arrangements, we may nevertheless encounter disputes over pricing and billing. Each third-party payer typically has different billing requirements, and the billing requirements of many payers have become increasingly difficult to meet.

Among the factors complicating our billing of third-party payers are:

disparity in coverage among various payers;

disparity in information and billing requirements among payers; and

incorrect or missing billing information, which is required to be provided by the prescribing health care practitioner.

These risks related to billing complexities, and the associated uncertainty in obtaining payment for our tests, could harm our business, financial condition and results of operations.

In the United States, the American Medical Association, or AMA, generally assigns specific billing codes for laboratory tests under a coding system known as Current Procedure Terminology, or CPT, which we and our customers must use to bill and receive reimbursement for our diagnostic tests. Once the CPT code is established, CMS establishes payment levels and coverage rules under Medicare while private payers establish rates and coverage rules independently. A CPT code specific to NIPT for aneuploidies came into effect in January 2015. Additionally, CMS adopted a new code

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set for diagnosis, commonly known as ICD-10, in October 2015. The AMA issued a CPT code for microdeletions in March 2016, which is scheduled to go into effect in January 2017; however, we anticipate that this new code could, in the near term, cause our microdeletions reimbursement to decline, either due to reduced reimbursement, or third-party payers declining to reimburse, under the new code. Furthermore, we cannot guarantee that we will be able to negotiate favorable rates for this code or receive reimbursement at all if we are unable to collect and publish additional data and obtain positive coverage determinations for Panorama for microdeletions. We do not currently have assay-specific CPT codes assigned for all of our tests, and there is a risk that we may not be able to obtain such codes, or if obtained, we may not be able to negotiate favorable rates for such codes. We currently submit for reimbursement using CPT codes that, based on the guidance of outside legal and coding experts, are determined to be the most appropriate for our testing, but there is a risk that these codes may be rejected or withdrawn or that third-party payers will seek refunds of amounts that they claim were inappropriately billed based on either the CPT code used, or the number of units billed. We accordingly cannot guarantee that our current or any future tests will have a CPT code assigned. In addition, there can be no guarantee that governmental and commercial third-party payers will establish positive coverage policies for our tests or adequate reimbursement rates for any CPT code we may use.

If the FDA were to begin actively regulating our tests as outlined in the FDA's October 3, 2014 draft guidances, we could incur substantial costs and delays associated with trying to obtain premarket clearance or approval and incur costs associated with complying with post-market controls.

We currently offer a number of prenatal genetic tests, including Panorama, and each of those tests is an LDT. In addition, we currently anticipate initially commercializing our planned cancer tests as LDTs. An LDT is generally considered to be a test that is designed, developed, validated and used within a single laboratory. The FDA takes the position that it has the authority to regulate such tests as medical devices under the Federal Food, Drug, and Cosmetic Act, or FDC Act, but it has generally exercised enforcement discretion with regard to LDTs. This means that even though the FDA believes it can impose regulatory requirements on LDTs, such as requirements to obtain premarket approval or clearance of LDTs, it has generally chosen not to enforce those requirements to date.

On October 3, 2014, the FDA issued draft guidances outlining its plan to actively regulate LDTs using a risk-based approach. The comment period for the draft guidances has closed; the draft guidances have not yet been finalized. According to the draft guidances, the FDA intends to fully regulate, in a phased-in manner, LDTs that it considers moderate-risk or high-risk, beginning with those within the high-risk category it considers "highest-risk devices." With regard to premarket review, under the proposed guidances, the highest-risk LDTs will be the subject of premarket submissions 12 months after the guidances are finalized. Premarket submission requirements will be phased in over the following four years for the remaining high-risk LDTs. Then, beginning after year five, moderate-risk LDTs will be required to be the subject of premarket submissions.

Based on our current understanding of the draft guidances, we believe that our current tests, including Panorama, would be treated as moderate-risk or high-risk. We do not expect that our current tests will be among the highest-risk devices. The FDA has indicated that high- and moderate-risk LDTs that are on the market if and when the draft guidances are finalized will remain on the market while the FDA reviews the submissions. We do not expect that we will be required to remove any of our current products from the market based on any final guidance if we comply with the requirements outlined in such final guidance.

The FDA's proposed framework in the draft guidances outlines post-market controls, including registration and listing or FDA notification, corrections and removals reporting and adverse event reporting, that would be required of all LDTs except those for forensic (law enforcement) use and certain LDTs for transplantation. For moderate- or high-risk tests, it also would require compliance with the QSR at the time the FDA clears a 510(k) for a test or the laboratory submits a PMA for a test. We would need to comply with these controls, which will be costly and time-consuming, and if we fail to comply we could be subject to enforcement action.

The regulation by the FDA of LDTs remains uncertain. The draft guidances have been the subject of considerable controversy, and it is unclear whether or when the FDA will finalize the guidances, or whether any final guidance would be substantially revised from the draft versions. In addition, Congress may act to provide further direction to the FDA on the regulation of LDTs.

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In the meantime, the FDA could require us to seek clearance or approval to offer our tests for clinical use even before it finalizes any future guidance. If FDA premarket review or approval is required, or if we voluntarily pursue FDA review or approval, for any of our existing or future tests, we may be forced to stop selling our tests or we may be required to modify claims or make other changes to our tests while we work to obtain FDA clearance or approval. Our business would be adversely affected while such review is ongoing and if we are ultimately unable to obtain premarket clearance or approval. For example, the regulatory 510(k) clearance or PMA process may involve, among other things, successfully completing analytical, pre-clinical and/or clinical studies beyond the studies we have already performed for each of our products and would involve submitting a premarket notification or filing a PMA application with the FDA. Performance achieved in published studies may not be repeated in later studies that would be required to obtain either FDA premarket clearance or approval. Limited results from earlier-stage verification studies, beyond the validation and other studies we have already performed for each of our products, may not accurately predict results from studies of larger numbers of subjects drawn from more diverse populations over a longer period of time. Unfavorable results from ongoing preclinical and clinical studies could result in delays, modifications or abandonment of ongoing or future clinical studies, or abandonment of a product development program or may delay, limit or prevent regulatory approvals or commercialization. In addition, we may require cooperation in our filings for FDA approval from third-party manufacturers of the components of our tests. If we are unable to obtain such required cooperation, we may be unable to achieve desired regulatory clearances or approvals, or may be delayed or be required to expend additional costs and other resources in doing so. We may face difficulty obtaining cooperation from our main sequencer and sequencing reagent supplier, Illumina, if we seek to achieve regulatory clearance or approval for Panorama, because Illumina is the parent company of Verinata, Inc., a direct competitor of ours in the NIPT field. Furthermore, if FDA premarket review or approval is required, our cash flows may be adversely affected, as most third party payers, including Medicaid, will not reimburse for use of medical devices which are required to be cleared or approved but which have not been.

We have informed the FDA of our intent to actively pursue a PMA for Panorama. We cannot assure you that Panorama or any of our other tests for which we pursue or are required to obtain premarket review by the FDA will be cleared or approved on a timely basis, if at all. In addition, if a test has been approved through a PMA, certain changes that we may make to improve the test, or as a result of issues with suppliers of the components of the test or if a supplier modifies its component upon which our approval relies, may need to be approved by the FDA before we can implement them, which could increase the time and expense involved in rolling such changes out to the commercial market. Ongoing compliance with FDA regulations would increase the cost of conducting our business and subject us to heightened regulation by the FDA and penalties for failure to comply with these requirements, any of which may adversely impact our business and results of operations.

Furthermore, the FDA or the Federal Trade Commission may object to the materials and methods we use to promote the use of our current prenatal tests or other LDTs we may develop in the future, and may initiate enforcement actions against us. Enforcement actions by the FDA may include, among others, untitled or warning letters; fines; injunctions; civil or criminal penalties; recall or seizure of current or future tests, products or services; operating restrictions and partial suspension or total shutdown of production.

Failure to obtain necessary regulatory approvals in foreign jurisdictions may adversely affect our ability to expand our operations internationally.

An important part of our business strategy is to expand and offer our tests internationally, either directly or through our licensees. As we do so, we will become increasingly subject to or impacted by the regulatory requirements of foreign jurisdictions, which are varied and complex. For example, our tests may be subject to the regulatory approval requirements for each foreign country in which they are sold by us or a laboratory partner or licensee under our cloud-based distribution model, and our future performance would depend on us or our partners or licensees obtaining any necessary regulatory approvals in a timely manner. In addition, as further described in the risk factor entitled “Risks Related to Our Business and Industry—We rely on a limited number of suppliers or, in some cases, single suppliers, for some of our laboratory instruments and materials and may not be able to find replacements or immediately transition to alternative suppliers,” blood collection tubes sourced solely from Streck are required to run our tests. These blood collection tubes are CE Marked by the European Commission; however, if such blood collection tubes are not registered in jurisdictions that do not accept a CE Mark, we may be unable to expand our business in such jurisdictions.

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Regulatory approval can be a lengthy, expensive and uncertain process. In addition, regulatory processes are subject to change, and new or changed regulations can result in unanticipated delays and cost increases. We or our partners or licensees may not be able to obtain foreign regulatory approvals on a timely basis, if at all, which may cause us to incur additional costs or prevent us from marketing our tests in foreign countries.

Changes in laws and regulations, or in their application, may adversely affect our business, financial condition and results of operations.

The clinical laboratory testing industry is highly regulated, and failure to comply with applicable regulatory, supervisory or licensing requirements may adversely affect our business, financial condition and results of operations. In particular, the laws and regulations governing the marketing and research of clinical diagnostic testing are extremely complex and in many instances there are no clear regulatory or judicial interpretations of these laws and regulations, which increases the risk that we may be found to be in violation of these laws.

Furthermore, the molecular diagnostics industry as a whole is a growing industry and regulatory agencies such as Health and Human Services, or HHS, or the FDA may apply heightened scrutiny to new developments in the field. While we have taken steps to ensure compliance with the current regulatory regime in all material respects, given its nature and our geographical diversity, there could be areas where we are non-compliant. Any change in the laws or regulations relating to our business may require us to implement changes to our business or practices, and we may not be able to do so in a timely or cost-effective manner. Should we be found to be non-compliant with regulatory requirements, we may be subject to sanctions which could include required changes to our operations, adverse publicity, substantial financial penalties and criminal proceedings, which may adversely affect our business, financial condition and results of operations by increasing our cost of compliance or limiting our ability to develop, market and commercialize our tests.

In addition, there has been a recent trend of increased U.S. federal and state regulation of payments made to physicians, which are governed by laws and regulations including the Stark law. Among other requirements, the Stark law requires laboratories to track, and places a cap on, non-monetary compensation provided to referring physicians.

While we have a compliance plan to address compliance with government laws and regulations, including applicable fraud and abuse laws and regulations, the evolving commercial compliance environment and the need to build and maintain robust and scalable systems to comply with regulations in multiple jurisdictions with different compliance and reporting requirements increases the possibility that we could inadvertently violate one or more of these requirements.

Our business could be adversely impacted by CMS' adoption of the new code set for diagnoses.

CMS adopted a new code set for diagnosis, commonly known as ICD-10, which significantly expands the code set for diagnoses. As required, we implemented the new code set on October 1, 2015. Any failure of third-party payers or health care practitioners to properly transition to the use of ICD-10 codes within the required timeframe could have an adverse impact on reimbursement, days’ sales outstanding and cash collections. In addition, health care practitioners may fail to provide appropriate codes for ordered tests leading to delays in billing, which could result in increased costs and decreased collection of payment. As a result, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and net revenues. For further discussion regarding code sets, see “—Our revenues may be adversely impacted if third-party payers withdraw coverage or provide lower levels of reimbursement due to changing policies, billing complexities or other factors.”

If we fail to comply with federal, state and foreign laboratory licensing requirements, we could lose the ability to perform our tests or experience disruptions to our business.

We are subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA regulations require clinical laboratories to obtain a certificate and mandate specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management and quality assurance. CLIA certification is also required in order for us to be eligible to bill state and federal healthcare programs, as well as

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many private third-party payers, for our tests. To renew these certifications, we are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random inspections of our clinical laboratory.

We are also required to maintain certain state licenses to conduct testing in our laboratories. California law establishes standards for the day-to-day operation of our clinical laboratory in San Carlos, California, including the training and skills required of personnel and quality control matters. We maintain a license in good standing with the California Department of Health Services, or DHS. In addition, we have obtained a license for our San Carlos laboratory from the New York Department of Health, or DOH, which mandates proficiency testing regardless of whether such laboratories are located in New York. If we are found to be out of compliance with either California or New York requirements, DHS or DOH may, among others, suspend, restrict or revoke our license for that state, assess substantial civil monetary penalties, or impose specific corrective action plans. Any such actions could materially and adversely affect our business.

Moreover, some states require that we hold licenses to test samples from patients in those states. We have obtained licenses from states that we believe require us to do so, and we intend to comply with similar requirements that we may become aware of for any other states. However, we cannot assure you that the regulators in each of the states will at all times find us to be in compliance with the applicable laws of their respective state, which may result in suspension, limitation, revocation or annulment of our laboratory’s license for that state, censure, or civil monetary penalties, and would result in our inability to test samples from patients in that state.

CMS also has the authority to impose a wide range of sanctions, including revocation of a laboratory’s CLIA certification along with a bar on the ownership or operation of any CLIA-certified laboratory by any owners or operators of the deficient laboratory.

If we were to lose our CLIA certification or any required state license, or if any sanction were imposed upon us under CLIA, its implementing regulations, or state or foreign laws or regulations governing licensure, or any failure by us to renew a CLIA certificate, a state license or accreditation, we would not be able to operate our clinical laboratory and offer our testing services, in some or all states or countries, which would materially and adversely impact our business and results of operations.

Changes in government healthcare policy could increase our costs and negatively impact coverage and reimbursement for our tests by governmental and other third-party payers.

The U.S. government has shown significant interest in pursuing healthcare reform and reducing healthcare costs. Government healthcare policy has been and, we expect, will continue to be a topic of extensive legislative and executive activity in the U.S. federal and many U.S. state governments. As a result, our business could be affected by significant and potentially unanticipated changes in government healthcare policy, such as changes in reimbursement levels by public third-party payers. Any of these or other changes could substantially impact our revenues, increase costs and divert management attention from our business strategy. Going forward, we cannot predict the full impact of governmental healthcare policy changes on our business, financial condition and results of operations.

In the United States, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, or collectively, the PPACA, was signed into law in March 2010 and significantly impacts the U.S. pharmaceutical and medical device industries, including the diagnostics sector, in a number of ways. Among other things, the PPACA expands current health care fraud and abuse laws such as the False Claims Act and the Anti-Kickback Statute, including required disclosures of financial arrangements with physician customers, lower thresholds for violations, new government investigative powers, and enhanced penalties for such violations. The PPACA also created a new system of health insurance "exchanges," designed to make health insurance policies available to individuals and certain groups through state- or federally-administered marketplaces in addition to existing channels for obtaining health insurance coverage. In connection with such exchanges, certain "essential health benefits" are intended to be made more consistent across plans, setting a baseline coverage level. The states (and the federal government) have some discretion in determining the definition of "essential health benefits" and we cannot predict at this time whether Panorama or our other tests will fall into a benefit category deemed "essential" for coverage purposes across the plans offered in any or all of the exchanges. If Panorama or any of our other tests are not covered by plans offered in the health insurance exchanges, our business, financial condition and results of operations could be adversely affected. There have

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been a number of proposed legislative initiatives with respect to the PPACA, including possible repeal of the PPACA; and although the Supreme Court has upheld the constitutionality of certain provisions of the PPACA that have been challenged, the newly-elected United States President and Congress have indicated a desire to make changes to or eliminate the entirety of the PPACA. Because it is unclear whether or not, or how, the PPACA may change, and whether and to what extent NIPT may be affected, we are uncertain how our business may be impacted.

In addition to the PPACA, various healthcare reform proposals have also emerged from federal and state governments. The Protecting Access to Medicare Act of 2014, or PAMA, introduces a multi-year pricing program for services paid under the CLFS that is designed to bring Medicare allowable amounts in line with the amounts paid by private payers. CMS, which is responsible for implementing PAMA, recently released a final rule for implementation of PAMA. Under the rule, certain laboratories will be required to report third-party payer rates and test volumes; laboratories with low Medicare revenues, such as Natera, are excluded from reporting. Beginning in January 2018, the Medicare payment rate for these tests will be equal to the weighted median private payer rate reported to CMS; as a result, there may be a decline in CLFS payment rates due to the often lower negotiated private payer rates applicable to large commercial laboratories that were required to report to CMS. In addition, federal budgetary limitations and changes in healthcare policy, such as the creation of broad limits for our tests or requirements that beneficiaries of government health plans pay for, or pay for higher, portions of clinical laboratory tests or services received, could substantially diminish the sale, or inhibit the utilization, of our tests in the future, increase costs and adversely affect our ability to generate revenues and achieve profitability.

We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or how any such future legislation, regulation or initiative may affect us. The taxes imposed by the new federal legislation and the expansion of government's role in the U.S. healthcare industry, as well as changes to the reimbursement amounts paid by payers for our current and future tests, may adversely affect the volumes of services and tests that we provide and may therefore adversely affect our business, financial condition, results of operations, and cash flows.

If we or our laboratory partners, consultants or commercial partners act in a manner that violates healthcare fraud and abuse laws or otherwise engage in misconduct, we may be subject to civil or criminal penalties.

We are subject to healthcare fraud and abuse regulation and enforcement by both the U.S. federal government and the states in which we conduct our business. The laws that may affect our ability to operate include:

HIPAA, which created federal civil and criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and also imposes obligations with respect to maintenance of the privacy and security, and transmission, of individually identifiable health information;

federal and state laws and regulations governing informed consents for genetic testing and the use of genetic material;

state laws and regulations governing the submission of claims, as well as billing and collection practices, for healthcare services;

the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs such as Medicare;

the federal False Claims Act which prohibits, among other things, the presentation of false or fraudulent claims for payment from Medicare, Medicaid, or other government-funded third-party payers;

federal laws and regulations governing the Medicare program, providers of services covered by the Medicare program, and the submission of claims to the Medicare program, as well as the Medicare Manuals issued by CMS and the local medical policies promulgated by the Medicare Administrative Contractors with respect to the implementation and interpretation of such laws and regulations;

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the federal Stark physician self-referral law, which prohibits a physician from making a referral for certain designated health services covered by the Medicare program (and according to case law in some jurisdictions, the Medicaid program as well), including laboratory and pathology services, if the physician or an immediate family member has a financial relationship with the entity providing the designated health services, unless the financial relationship falls within an applicable exception to the prohibition, as well as state law equivalents of the Stark law;

the federal Civil Monetary Penalties Law, which prohibits, among other things, the offer or transfer of remuneration to a Medicare or state healthcare program beneficiary if the person knows or should know it is likely to influence the beneficiary's selection of a particular provider, practitioner or supplier of services reimbursable by Medicare or a state healthcare program, unless an exception applies;

the prohibition on reassignment by the program beneficiary of Medicare claims to any party; and

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

Furthermore, a development affecting our industry is the increased enforcement of the federal False Claims Act and, in particular, actions brought pursuant to the False Claims Act's "whistleblower" or "qui tam" provisions. The False Claims Act imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal governmental payer program. The qui tam provisions of the False Claims Act allow a private individual to bring civil actions on behalf of the federal government for violations of the False Claims Act and permit such individuals to share in any amounts paid by the defendant to the government in fines or settlement. When an entity is determined to have violated the False Claims Act, it is subject to mandatory damages of three times the actual damages sustained by the government, plus mandatory civil penalties ranging from $5,500 to $11,000 for each false claim. In addition, various states have enacted false claim laws analogous to the federal False Claims Act, and in some cases go even further because many of these state laws apply where a claim is submitted to any third-party payer and not merely a governmental payer program.

Many of these laws and regulations have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. We have adopted policies and procedures designed to comply with these laws, and in the ordinary course of our business, we conduct internal reviews of our compliance with these laws. However, the rapid growth and expansion of our business both within and outside of the United States may increase the potential for violating these laws or our internal policies and procedures, and the uncertainty around the interpretation of these laws and regulations increases the risk that we may be found in violation of these or other laws and regulations, or of allegations of such violations, including pursuant to private qui tam actions brought by individual whistleblowers in the name of the government as described above. If our operations, including the conduct of our employees, distributors, consultants and commercial partners, are found to be in violation of any laws or regulations that apply to us, we may be subject to penalties, including civil, criminal and administrative penalties, damages, fines, disgorgement of profits, exclusion from participation in government programs, injunctions, recall or seizure of products, total or partial suspension of production, denial or withdrawal of pre-marketing product approvals, contractual damages, reputational harm, diminished profits and future earnings and the curtailment or restructuring of our operations, any of which could materially and adversely affect our business, financial condition and results of operations.

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Failure to comply with privacy and security laws and regulations could result in fines, penalties and damage to our reputation and have a material adverse effect on our business.

The federal HIPAA privacy and security regulations, including the expanded requirements under the Health Information Technology for Economic and Clinical Health Act, or HITECH, which was enacted as part of the American Recovery and Reinvestment Act of 2009, establish comprehensive federal standards with respect to the use and disclosure of protected health information by health plans, health care providers, and health care clearinghouses, in addition to setting standards to protect the confidentiality, integrity and security of protected health information. The regulations establish a complex regulatory framework on a variety of subjects, including:

the circumstances under which the use and disclosure of protected health information are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, activities to obtain payments for our services, and its health care operations activities;

a patient’s right to access, amend and receive an accounting of certain disclosures of protected health information;

the content of notices of privacy practices for protected health information;

administrative, technical and physical safeguards required of entities that use or receive protected health information; and

the protection of computing systems that maintain protected health information.

We have implemented policies and procedures related to compliance with the HIPAA privacy and security regulations as required by law. The privacy and security regulations establish minimum requirements, and do not supersede state laws that are more stringent. Therefore, we are required to comply with both federal privacy and security regulations and various state privacy and security laws and regulations. The federal privacy regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization, for purposes other than payment, treatment or health care operations (as defined by HIPAA), except for disclosures for various public policy purposes and other specified permitted purposes. HIPAA, as amended by HITECH, provides for significant fines and other penalties for wrongful use or disclosure of protected health information in violation of privacy and security regulations, including potential civil and criminal fines and penalties. We could also incur damages under state laws pursuant to an action brought by a private party for the wrongful use or disclosure of confidential health information or other private personal information. In addition, other federal and state laws that protect the privacy and security of patient information may be subject to enforcement and interpretation by various governmental authorities and courts, resulting in complex compliance issues.

In addition, laws and regulations of the European Union, as well as other countries, protect the use and disclosure of personal information. In particular, the data protection laws in the European Union are generally more stringent and apply to a broader range of personal data than those in the United States, and impose various requirements on U.S.-based companies, such as ours, relating to collecting, receiving, processing and storing personal data from the European Union. As we continue to expand and grow our business, compliance with these laws and regulations may result in increased costs, and failure to comply may result in significant fines, penalties and damage to our reputation.

Changes in the way the FDA regulates the reagents, other consumables, and testing equipment we use when developing, validating, and performing our tests could result in delay or additional expense in bringing our tests to market or performing such tests for our customers.

Many of the sequencers, reagents, kits and other consumable products used to perform our prenatal testing, as well as the instruments and other capital equipment that enable the testing, are offered for sale as analyte specific reagents, or ASRs, or for research use only, or RUO. ASRs consist of single reagents or primer pairs, which are intended for use in a diagnostic application for the identification and quantification of an individual chemical substance in biological specimens. As medical devices, ASRs must comply with the QSR provisions and other device requirements, but most are exempt from the 510(k) and PMA premarket review processes. Products that are intended for research use only and are labeled as RUO are exempt from compliance with the FDA requirements, including the approval or clearance and other product quality requirements for medical devices. A product labeled RUO but intended for clinical diagnostic use may be

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viewed by the FDA as adulterated and misbranded under the FDC Act and subject to FDA enforcement action. The FDA has said it will consider the totality of the circumstances surrounding distribution and use of an RUO product, including how the product is marketed and to whom, when determining its intended use. The FDA could disagree with a supplier's assessment that the supplier’s products are ASRs, or could conclude that products labeled as RUO are actually intended for clinical diagnostic use, and could take enforcement action against the supplier, including requiring the supplier to seek clearance or approval for the products. The supplier may cease selling the products, and we may be unable to obtain an acceptable substitute on commercially reasonable terms or at all, which could significantly and adversely affect our ability to provide timely testing results to our customers or could significantly increase our costs of conducting business.

The sequencers and reagents supplied to us by Illumina and the blood collection tubes supplied to us by Streck are labeled as RUO in the United States. If the FDA were to require clearance or approval for the sale of Illumina's sequencers and if Illumina does not obtain such clearance or approval, we would have to find an alternative sequencing platform for Panorama. We currently have not validated an alternative sequencing platform that would work for Panorama in a commercially viable manner. If we were not successful in selecting, acquiring on commercially reasonable terms and implementing an alternative platform on a timely basis, our business, financial condition and results of operations could be adversely affected. Similarly, a decision by the FDA to require clearance or approval for the sale by Streck of the blood collection tubes used for Panorama, or a finding that any of our other suppliers failed to comply with applicable requirements, could result in interruptions in our ability to supply our products to the market and adversely affect our operations. Furthermore, if and to the extent that we begin to supply customers with products that are RUO, we would also be subject to the regulatory risks described above.

Our use of hazardous materials in the development of our tests exposes us to risks related to accidental contamination or injury and requires us to comply with regulations governing hazardous waste materials.

Our research and development activities involve the controlled use of hazardous materials and chemicals. We cannot eliminate the risk of accidental contamination or injury to employees or third parties from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our resources or any applicable insurance coverage we may have. In addition, we are subject on an ongoing basis to federal, state and local regulations governing the use, storage, handling and disposal of these materials and specified hazardous waste materials. An increase in the costs of compliance with such laws and regulations could harm our business and results of operations.

If the validity of an informed consent from a patient intake for Panorama or our other tests is challenged, we could be precluded from billing for such testing or forced to stop performing such tests, which would adversely affect our business and financial results.

All clinical data and blood samples that we receive are required to have been collected from individuals who have provided appropriate informed consent for us to perform our testing, both commercially and in clinical trials. We seek to ensure that the individuals from whom the data and samples are collected do not retain or have conferred on them any proprietary or commercial rights to the data or any discoveries derived from them. Our partners operate in a number of different countries in addition to the United States, and, to a large extent, we rely upon them to comply with the individual’s informed consent and with U.S. and international laws and regulations. The collection of data and samples in many different countries results in complex legal questions regarding the adequacy of informed consent and the status of genetic material under a large number of different legal systems. The individual's informed consent obtained in any particular country could be challenged in the future, and those informed consents could be deemed invalid, unlawful or otherwise inadequate for our purposes. Any findings against us, or our partners, could deny us access to, or force us to stop testing samples in, a particular country or could call into question the results of our clinical trials. We could also be precluded from billing third-party payers for tests for which informed consents are challenged, or could be requested to refund amounts previously paid by third-party payers for such tests. We could become involved in legal challenges, which could require significant management and financial resources and adversely affect our revenues and results of operations.

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Risks Related to Our Intellectual Property

Any failure to effectively protect our proprietary technologies could harm our competitive position.

Our success and ability to compete depend, in part, on our ability to prevent third parties from making, using, selling, offering to sell or importing our products or product candidates, which requires us to develop proprietary products and technologies and to maintain adequate protection of our intellectual property in the United States and other countries. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. Any finding that our patents or patent applications are unenforceable could harm our ability to prevent others from practicing the related technology, and a finding that others have claims of inventorship or ownership rights to our patents and applications could require us to obtain certain rights to practice related technologies, which may not be available on favorable terms, if at all. In addition, our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing similar or alternative competing products or design around our patented technologies, and may therefore fail to provide us with any competitive advantage. Furthermore, as our issued patents expire, we may lose some competitive advantage as others develop competing products that would have been covered by the expired patents, and, as a result, we may lose revenue.

The patent positions of molecular diagnostic companies, including ours, can be highly uncertain and involve complex legal and factual questions, and have been and may continue to be affected by developments or uncertainty in the patent statute, patent case law or patent office rules and regulations. This uncertainty may materially affect our patents, our ability to obtain patents or the patents and patent applications of our collaborators and licensors. Therefore, we cannot assure you that any current or future patent applications will result in the issuance of patents that will protect our products or provide us with any competitive advantage.

The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant challenges in establishing and enforcing their proprietary rights outside of the United States. These challenges can be caused by the absence of rules and methods for the establishment and enforcement of intellectual property rights outside of the United States.

We may be required to file infringement lawsuits to protect our interests, which can be expensive and time consuming. We cannot assure you that we would be successful in proving any such infringement by a third party, and we may become subject to counterclaims by such third parties. Our patents or patent applications may be declared invalid or unenforceable, or narrowed in scope, as a result of such litigation. Some third-party infringers may have substantially greater resources than us and may be able to sustain the costs of complex infringement litigation more effectively than we can. Even if we prevail in an infringement action, we cannot assure you that we would be fully or partially financially compensated for any harm to our business. We may be forced to enter into a license or other agreement with the infringing third party on terms less profitable or otherwise less commercially acceptable to us than those negotiated between a willing licensee and a willing licensor. Any inability to stop third-party infringement could result in loss in market share of some of our products or even lead to a delay, reduction and/or inhibition of our development, manufacture or sale of some of our products. A product produced and sold by a third-party infringer may not meet our or other regulatory standards or may not be safe for use, which could cause irreparable harm to the reputation of our products, which in turn could result in substantial loss in our market share and profits.

Our patent procurement and enforcement positions are subject to numerous additional risks, including the following:

we may fail to timely file for patent protection for inventions that are important to our success;

we cannot be certain that we were the first to invent the inventions covered by pending patent applications or that we were the first to file such applications and, if we are not, we may be subject to priority or derivation disputes;

we may be required to disclaim part or all of the term of certain patents or part or all of the term of certain patent applications;

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we could inadvertently abandon a patent or patent application, resulting in the loss of protection of certain intellectual property rights in a particular country;

our competitors or others may have filed, and may in the future file, conflicting patent claims covering technology similar or identical to ours. The costs associated with challenging conflicting patent claims could be substantial, and it is possible that our efforts would be unsuccessful and may result in a loss of our patent position and the issuance or validation of the competing claims. Should such competing claims cover our technology, we could be required to obtain rights to those claims at substantial cost;

there may be prior art of which we are not aware that may affect the validity of a patent claim. There also may be prior art of which we are aware that we do not believe affects the validity or enforceability of a claim, but which may nonetheless ultimately be found to do so;

certain of our intellectual property was partly supported by a U.S. government grant awarded by the National Institutes of Health, and the government accordingly has certain rights in this intellectual property, including a non-exclusive, non-transferable, irrevocable worldwide license to use applicable inventions for any governmental purpose. Such rights also include "march-in" rights, which refer to the right of the U.S. government to require us to grant a license to the technology to a responsible applicant if we fail to achieve practical application of the technology or if action is necessary to alleviate health or safety needs, to meet requirements of federal regulations or to give preference to U.S. industry.

Any of these factors could adversely affect our ability to obtain commercially relevant or competitively advantageous patent protection for our products.

Third party claims of intellectual property infringement could result in litigation or other proceedings, which would be costly and time-consuming, and could limit our ability to commercialize our products.

Our success depends in part on our non-infringement of the patents or intellectual property rights of third parties. We operate in a crowded technology area in which multiple third parties own or control potentially relevant intellectual property, including patents, and there has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the genetic diagnostics industry. Third parties, including our competitors, may assert that we are employing their proprietary technology without authorization or that we are otherwise infringing their intellectual property rights. Defending against infringement claims is costly and may divert the attention of our management and technical personnel. If we are unsuccessful in defending against patent infringement claims, we could be forced to pay potentially substantial monetary damages; to obtain licenses from third parties, which we may be unable to do on acceptable terms, if at all, and which may require us to make substantial royalty payments; and/or be subjected to an injunction, which could block our ability to develop, commercialize and sell our products, or require us to make changes in our operating procedures that would be costly to implement, and could cause delays in product introductions while we attempt to develop alternative methods or products to avoid infringing third party patents or proprietary rights. Our patents or patent applications may be declared invalid or unenforceable, or narrowed in scope, as a result of such litigation. Any of these or other adverse outcomes could materially and adversely affect our ability to offer our tests, as well as our financial condition and our results of operations, which would have a material adverse effect on our business.

We have in the past and may also in the future be involved with intellectual property litigation or patent office actions. For example, we were recently engaged in patent litigation with Sequenom. For more information on our current legal and regulatory proceedings, see Part II, Item 1—Legal Proceedings. We expect that the number of such claims may increase as the number of products and the level of competition in our industry segments grows.

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 have significantly stronger, larger and/or more mature patent portfolios than we have. In addition, future litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenues and against whom our own patents may provide little or no deterrence or protection.

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In addition, our agreements with some of our customers, suppliers or other entities with whom we do business require us to defend or indemnify these parties to the extent they become involved in infringement claims, including the types of claims described above. We could also voluntarily agree to defend or indemnify third parties if we determine it to be in the best interests of our business relationships. If we are required or agree to defend or indemnify third parties in connection with any infringement claims, we could incur significant costs and expenses that could adversely affect our business, financial condition and results of operations.

If we are not able to adequately protect our trade secrets and other proprietary information, the value of our technology and products could be significantly diminished.

We rely on trade secret protection and proprietary know-how protection for our confidential and proprietary information, and we have taken security measures to protect this information. These measures, however, may not provide adequate protection for our trade secrets, know-how, or other confidential information. For example, although we have a policy of requiring our consultants, advisors and collaborators to enter into confidentiality agreements and our employees to enter into invention, non-disclosure and non-compete agreements, we cannot assure you that such agreements will provide for a meaningful protection of our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure of information, including as a result of breaches of our physical or electronic security systems. Any action to enforce our rights is likely to be time consuming and expensive, and may ultimately be unsuccessful, or may result in a remedy that is not commercially valuable. These risks are heightened in countries where laws or law enforcement practices may not protect proprietary rights as fully as in the United States or Europe. Any unauthorized use or disclosure of, or access to, our trade secrets, know-how or other proprietary information, whether accidentally or through willful misconduct, could have a material adverse effect on our programs and our strategy, and on our ability to compete effectively.

If our trademarks and trade names are not adequately protected, we may not be able to build name recognition in our markets of interest, and our business may be adversely affected.

Failure to maintain our trademark registrations, or to obtain new trademark registrations in the future, could limit our ability to protect our trademarks and impede our marketing efforts in the countries in which we operate. We may not be able to protect our rights to trademarks and trade names which we may need to build name recognition with potential partners or customers in our markets of interest. As a means to enforce our trademark rights and prevent infringement, we may be required to file trademark claims against third parties or initiate trademark opposition proceedings. This can be expensive, particularly for a company of our size, and time-consuming, and we may not be successful. Our registered or unregistered trademarks or trade names may be challenged, infringed, circumvented, declared generic or determined to be infringing on other marks.

Our pending trademark applications in the United States and in other foreign jurisdictions where we may file may not be allowed or may subsequently be opposed. Even if these applications result in registration of trademarks, third parties may challenge our use or registration of these trademarks in the future. Over the long term, if we are unable to establish name recognition based on our trademarks and trade names, then we may not be able to compete effectively and our business may be adversely affected.

We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed confidential information of third parties.

We employ individuals who were previously employed at other biotechnology or diagnostic companies. We may be subject to claims that we or our employees, consultants or independent contractors have inadvertently or willfully used or disclosed confidential information of our employees' former employers or other third parties. We may also be subject to claims that former employers or other third parties have an ownership interest in our patents. Litigation may be necessary to defend against these claims, and if we are unsuccessful, we could be required to pay substantial damages and could lose rights to important intellectual property. Even if we are successful, litigation could result in substantial costs to us and could divert the time and attention of our management and other employees.

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Risks Related to Ownership of Our Common Stock

The market price of our common stock has been and may be volatile which could subject us to litigation.

The trading prices of the securities of life sciences companies, including ours, have been and may continue to be highly volatile. Accordingly, the market price of our common stock is likely to be subject to wide fluctuations in response to numerous factors, many of which are beyond our control, such as those in this "Risk Factors" section and others including:

actual or anticipated variations in our and our competitors' results of operations;

announcements by us or our competitors of new products, significant acquisitions, strategic and commercial partnerships and relationships, joint ventures, collaborations or capital commitments;

changes in reimbursement practices by current or potential payers;

issuance of new securities analysts' reports or changed recommendations for our stock;

periodic fluctuations in our revenue, due in part to the way in which we recognize revenue;

actual or anticipated changes in regulatory oversight of our products;

developments or disputes concerning our intellectual property or other proprietary rights;

commencement of, or our involvement in, litigation;

announcement or expectation of additional debt or equity financing efforts;

sales of our common stock by us, our insiders or our other stockholders;

any major change in our management and

general economic conditions and slow or negative growth of our markets.

In addition, if the market for life sciences stocks or the stock market in general experiences uneven investor confidence, the market price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The market price of our common stock might also decline in reaction to events that affect other companies within, or outside, our industry even if these events do not directly affect us. Some companies that have experienced volatility in the trading price of their stock have been the subject of securities class action litigation. For example, as described further in Part II, Item 1—Legal Proceedings, purported securities class action lawsuits have been filed against Natera, our directors and certain of our officers and stockholders. Under certain circumstances, we have contractual and other legal obligations to indemnify and to incur legal expenses on behalf of current and former directors and officers, and on behalf of our current or former underwriters, in connection with the litigation described in Part II, Item 1 and in connection with any future lawsuits. Any lawsuit to which we are a party, with or without merit, may result in an unfavorable judgment. We also may decide to settle lawsuits on unfavorable terms. Any such negative outcome could result in payments of substantial damages or fines, damage to our reputation or adverse changes to our offerings or business practices. Defending against litigation is costly and time-consuming, and could divert our management's attention and resources. Furthermore, during the course of litigation, there could be negative public announcements of the results of hearings, motions or other interim proceedings or developments, which could have a material adverse effect on the market price of our common stock.

We will continue to incur significantly increased costs and devote substantial management time as a result of being a public company.

As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. For example, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and are required to comply with the applicable requirements of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as rules and regulations subsequently implemented by the SEC and the Nasdaq Global Select

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Market, including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. We expect that compliance with these requirements will continue to increase our legal and financial compliance costs and will make some activities more time consuming and costly. Our management and other personnel have limited experience managing a public company and preparing public filings. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. In particular, we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act, which will increase when we are no longer an emerging growth company, as defined by the Jumpstart Our Businesses Act of 2012, or the JOBS Act. We hired, and we expect that we will need to continue to hire, additional accounting and financial staff with appropriate public company experience and technical accounting knowledge and may need to establish an internal audit function. We cannot predict or estimate the amount of additional costs we may incur as a public company or the timing of such costs. Additional compensation costs and any future equity awards will increase our compensation expense, which would increase our general and administrative expense and could adversely affect our profitability. Also, as a public company it is more expensive for us to obtain director and officer liability insurance on reasonable terms. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors, our board committees or as executive officers.

We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

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

For as long as we continue to be an emerging growth company, we intend to take advantage of certain other exemptions from various reporting requirements that are applicable to other public companies including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict whether investors will find our common stock less attractive because we rely on these exemptions, which could result in a less active trading market for our common stock and increased volatility in our stock price.

We will remain an emerging growth company until the earliest of (a) the end of the fiscal year (i) following the fifth anniversary of the closing of our IPO, or December 31, 2020, (ii) in which the market value of our common stock that is held by non-affiliates exceeds $700 million and (iii) in which we have total annual gross revenues of $1 billion or more during such fiscal year, and (b) the date on which we issue more than $1 billion in non-convertible debt in a three-year period.

If we are unable to implement and maintain effective internal controls over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be adversely affected.

As a public company, we are required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal controls over financial reporting and, beginning with our annual report for the year ending December 31, 2016, provide a management report on internal controls over financial reporting. The Sarbanes-Oxley Act also requires that our management report on internal controls over financial reporting be attested to by our independent registered public accounting firm, to the extent we are no longer an emerging growth company. We do not expect to have our independent registered public accounting firm attest to our management report on internal controls over financial reporting for so long as we are an emerging growth company.

If we have a material weakness in our internal controls over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. We are in the process of designing and implementing

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the internal controls over financial reporting required to comply with this obligation, which process will be time consuming, costly and complicated. If we identify material weaknesses in our internal controls over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner, if we are unable to assert that our internal controls over financial reporting are effective, or, when required in the future, if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal controls over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be adversely affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC, or other regulatory authorities.

We do not intend to pay dividends on our capital stock so any returns will be limited to changes in the value of our common stock.

We have never declared or paid any cash dividends on our capital 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 on our capital stock may be prohibited or limited by the terms of any current or future debt financing arrangement. Any return to stockholders will therefore be limited to the increase, if any, in the price of our common stock.

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 the price of our common stock to decline.

In the future, we may issue additional securities or 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. We also expect to issue common stock to employees and directors pursuant to our equity incentive plans. If we sell common stock, convertible securities or other equity securities in subsequent transactions, or common stock is issued pursuant to equity incentive plans, investors may be materially diluted. New investors in such subsequent transactions could gain rights, preferences and privileges senior to those of holders of our common stock.

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

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.

Certain holders of shares of our common stock are entitled to rights with respect to the registration of their shares under the Securities Act of 1933, as amended, or the Securities Act. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares held by our affiliates as defined in Rule 144 under the Securities Act. Any sales of securities by these stockholders could adversely affect the trading price of our common stock.

We may issue our shares of common stock or securities convertible into our common stock from time to time in connection with a financing, acquisition, investments or otherwise. Any such issuance could result in substantial dilution to our existing stockholders and cause the trading price of our common stock to decline.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If few securities analysts commence coverage of us, or if industry analysts cease coverage of us, the trading price for our common stock could be adversely affected. If one or more of the analysts who cover us downgrade our common stock or publish inaccurate or unfavorable research about our business, our common

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stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our common stock could decrease, which might cause our common stock price and trading volume to decline.

Insiders have substantial control over us and will be able to influence corporate matters.

As of September 30, 2016, our directors and executive officers and their affiliates beneficially own, in the aggregate, approximately 46.3% of our outstanding capital stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit stockholders' ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay or prevent a change in control of our company or changes in our management and, therefore, depress the market price of our common stock.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could depress the market price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions, among other things:

authorize the issuance of "blank check" preferred stock that our board of directors could use to implement a stockholder rights plan;

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;

eliminate the ability of our stockholders to call special meetings of stockholders;

establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at annual stockholder meetings;

establish a classified board of directors so that not all members of our board are elected at one time;

permit the board of directors to establish the number of directors;

provide that directors may only be removed "for cause" and only with the approval of 75% of our stockholders;

require super-majority voting to amend some provisions in our amended and restated certificate of incorporation and amended and restated bylaws; and

provide that the board of directors is expressly authorized to make, alter or repeal our amended and restated bylaws.

In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company. Section 203 imposes certain restrictions on merger, business combinations and other transactions between us and holders of 15% or more of our common stock.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders' ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a breach of fiduciary duty, any action asserting a claim against us arising pursuant to the Delaware General Corporation Law or any action asserting a claim against us that is governed by the internal affairs doctrine. This choice of forum

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provision may limit a stockholder's ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees and may discourage these types of lawsuits. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could harm our business, financial condition and results of operations.

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ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a)Recent Sales of Unregistered Securities

None.

(b)Use of Proceeds

On July 1, 2015, we consummated our initial public offering of 10,000,000 shares of our common stock at a public offering price of $18.00 per share. Subsequently on August 5, 2015, we completed the sale of 900,000 additional shares upon exercise of the underwriters’ over-allotment option. The offer and sale of all of the shares in the initial public offering were registered under the Securities Act pursuant to a registration statement on Form S-1 (File No. 333-204622), which was declared effective by the SEC on July 1, 2015. There have been no material changes in our planned use of proceeds from the offering as described in our final prospectus filed with the SEC pursuant to Rule 424(b) of the Securities Act.

(c)Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

ITEM 3 DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5 OTHER INFORMATION

None.

ITEM 6 EXHIBITS

See the Exhibit Index immediately following the signature page of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	NATERA, INC.

Date: November 10, 2016	By:	/ s / Matthew Rabinowitz
	Name:	Matthew Rabinowitz
	Title:	Chief Executive Officer, President, and Chairman
		(Principal Executive Officer)

	By:	/ s / Herm Rosenman
	Name:	Herm Rosenman
	Title:	Chief Financial Officer
		(Principal Financial and Accounting Officer)

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INDEX TO EXHIBITS


		Incorporated by Reference
Exhibit No.	Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
3.1	Amended and Restated Certificate of Incorporation of Natera, Inc.	8-K	001-37478	3.1	7/9/2015
3.2	Amended and Restated Bylaws of Natera, Inc.	8-K	001-37478	3.2	7/9/2015
10.1	First Amendment to Lease, dated October 6, 2016, by and between Registrant and BMR-201 Industrial Road LP.					X
31.1	Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.					X
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.					X
32.1†	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.					X
32.2†	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.					X
101.INS	XBRL Instance Document.					X
101.SCH	XBRL Taxonomy Extension Schema Document.					X
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document.					X
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document.					X
101.LAB	XBRL Taxonomy Extension Label Linkbase Document.					X

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		Incorporated by Reference
Exhibit No.	Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.					X

*Portions of this exhibit have been omitted pursuant to a request for confidential treatment. Omitted portions have been submitted separately to the Securities and Exchange Commission.

†The certifications attached as Exhibits 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are not deemed filed with the SEC and are not to be incorporated by reference into any filing of Natera, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, regardless of any general incorporation language contained in any filing.