Natera, Inc. - Quarter Report: 2017 September (Form 10-Q)

Table of Contents

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, 2017

☐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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):


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

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

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

As of October 30, 2017, the number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, was 53,768,979.

Table of Contents

Natera, Inc.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2017

TABLE OF CONTENTS


		Page

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Part I — Financial Information
	Item 1. Financial Statements (unaudited)	5
	Condensed Consolidated Balance Sheets at September 30, 2017 and December 31, 2016	5
	Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months Ended September 30, 2017 and 2016	6
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016	7
	Notes to Unaudited Interim Condensed Consolidated Financial Statements	8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	44
	Item 4. Controls and Procedures	44

Part II — Other Information
	Item 1. Legal Proceedings	45
	Item 1A. Risk Factors	46
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	85
	Item 3. Defaults Upon Senior Securities	85
	Item 4. Mine Safety Disclosures	85
	Item 5. Other Information	85
	Item 6. Exhibits	85
	Signatures	88

Table of Contents

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, obtain favorable coverage and reimbursement determinations from third-party payers, and expand geographically;

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;

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

the effect of improvements in our cost of goods sold;

the effect of changes in the way we account for our revenue;

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

competition in the markets we serve;

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

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 our availability to maintain a continued supply of laboratory instruments and materials and to run our tests;

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

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

our ability to successfully commercialize our EvercordTM cord blood and tissue banking service offering;

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

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

Table of Contents

our ability to retain and recruit key personnel;

our reliance on our direct sales efforts;

our expectations regarding acquisitions and strategic operations;

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.

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

Natera, Inc.

Condensed Consolidated Balance Sheets

(In thousands)


	September 30,		December 31,
	2017		2016
Assets		(unaudited)		(Note 2)
Current assets:
Cash and cash equivalents	$	11,211	$	15,256
Restricted cash, current portion		45		1,092
Short-term investments		135,017		130,860
Accounts receivable, net of allowance of $1,795 in 2017 and $1,890 in 2016		7,342		13,396
Inventory		9,188		6,414
Prepaid expenses and other current assets		6,437		7,097
Total current assets		169,240		174,115
Property and equipment, net		30,417		32,289
Restricted cash, long term portion		342		342
Other assets		4,057		3,934
Total assets	$	204,056	$	210,680
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	3,753	$	11,479
Accrued compensation		9,428		11,067
Other accrued liabilities		23,022		19,879
Deferred revenue		1,041		574
Short-term debt financing		50,097		49,624
Warrants		4,189		3,792
Total current liabilities		91,530		96,415

Long-term debt financing		73,202		—
Deferred rent, net of current portion		9,140		7,789
Total liabilities		173,872		104,204

Commitments and contingencies (Note 6)
Stockholders’ equity:
Common stock, $0.0001 par value: 750,000 shares authorized at both September 30, 2017 and December 31, 2016, respectively; 53,708 and 52,665 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively		6		5
Additional paid in capital		467,234		453,044
Accumulated deficit		(436,660)		(345,848)
Accumulated other comprehensive loss		(396)		(725)
Total stockholders’ equity		30,184		106,476
Total liabilities and stockholders’ equity	$	204,056	$	210,680

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

Table of Contents

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,
	2017		2016		2017		2016
Revenues
Product revenues	$	55,331	$	53,090	$	153,520	$	165,457
Licensing and other revenues		1,325		799		3,654		2,318
Total revenues		56,656		53,889		157,174		167,775
Cost and expenses
Cost of product revenues		33,558		33,761		100,355		97,074
Cost of licensing and other revenues		1,054		500		2,516		500
Research and development		12,609		11,345		37,045		30,403
Selling, general and administrative		34,478		34,938		106,369		98,573
Total cost and expenses		81,699		80,544		246,285		226,550
Loss from operations		(25,043)		(26,655)		(89,111)		(58,775)
Interest expense		(1,477)		(146)		(1,878)		(383)
Interest and other (expense) income, net		(437)		887		450		1,403
Loss before income taxes		(26,957)		(25,914)		(90,539)		(57,755)
Income tax expense		(162)		(103)		(273)		(103)
Net loss	$	(27,119)	$	(26,017)	$	(90,812)	$	(57,858)
Unrealized gain on available-for-sale securities, net of tax		67		(609)		329		1,750
Comprehensive loss	$	(27,052)	$	(26,626)	$	(90,483)	$	(56,108)

Net loss per share (Note 11):
Basic	$	(0.51)	$	(0.50)	$	(1.71)	$	(1.13)
Diluted	$	(0.51)	$	(0.50)	$	(1.71)	$	(1.13)
Weighted-average number of shares used in computing basic and diluted net loss per share:
Basic		53,447		52,012		53,100		51,301
Diluted		53,447		52,012		53,100		51,301

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

Table of Contents

Natera, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(In thousands)


	Nine months ended
	September 30,
	2017		2016
Operating activities
Net loss	$	(90,812)	$	(57,858)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		5,320		4,177
Stock-based compensation		8,406		7,965
Premium amortization and discount accretion on investment securities		703		1,145
Amortization of debt discount		51		—
Inventory excess adjustments		413		—
Loss on disposal of property and equipment		12		—
Impairment of assets		576		407
Non-cash interest accrual		1,825		383
Loss (gain) on investments		55		(192)
Loss (gain) from changes in fair value of warrants		397		(91)
Provision for doubtful accounts		(93)		354
Changes in operating assets and liabilities:
Accounts receivable		6,147		(3,900)
Inventory		(3,187)		(1,156)
Prepaid expenses and other current assets		660		(4,057)
Restricted cash		1,047		54
Other assets		476		(3,028)
Accounts payable		(4,548)		1,653
Accrued compensation		(1,639)		1,662
Other accrued liabilities		3,724		1,552
Deferred revenue		467		432
Deferred rent, net of current portion		1,351		6,092
Net cash used in operating activities		(68,649)		(44,406)

Investing activities
Purchases of investments		(184,263)		(48,519)
Proceeds from sale of investments		55,352		59,185
Proceeds from maturity of investments		124,325		34,000
Purchases of property and equipment, net		(9,147)		(14,577)
Net cash (used in) provided by investing activities		(13,733)		30,089

Financing activities
Proceeds from exercise of stock options		1,834		2,722
Proceeds from issuance of common stock under employee stock purchase plan		1,503		970
Borrowings under long-term debt facility		75,000		—
Borrowings under credit facility		—		8,000
Repayment under credit facility		—		(1,000)
Net cash provided by financing activities		78,337		10,692

Net decrease in cash		(4,045)		(3,625)
Cash at beginning of period		15,256		28,947
Cash at end of period	$	11,211	$	25,322

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

Table of Contents

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 determines its operating segments based on the way it organizes its business to make operating decisions and assess performance. The Company has only one segment, which is the discovery, development and commercialization of genetic testing services, and it 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; Vistara (“Vistara”), a single-gene mutations screening test performed to identify single-gene disorders; 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 and launch tests based on the Company’s technology. The Company also offers Evercord, which is a cord blood and cord tissue processing and storage service; and SignateraTM, a circulating tumor DNA technology that analyzes and tracks mutations specific to an individual's tumor, for research use only by oncology researchers and biopharmaceutical companies.

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, 2017, 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, 2016 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, 2016 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2017.

Liquidity Matters

The Company has incurred net losses since its inception and anticipates net losses and negative operating cash flows for the near future. For the nine months ended September 30, 2017, the Company had a net loss of $90.8 million, and as of September 30, 2017, it had an accumulated deficit of $436.7 million. At September 30, 2017, the Company had $11.2 million in cash and cash equivalents, $135.0 million in marketable securities, $50.1 million of outstanding balance of the Credit Line (as defined below in Note 8) including accrued interest, and $73.2 million of net carrying amount of the 2017 Term Loan (as defined below). While the Company has introduced multiple products that are generating revenues,

Table of Contents

these revenues have not been sufficient to fund all operations. Accordingly, the Company has funded the portion of operating costs that exceeds revenues through a combination of equity issuances, debt issuances, and other financings.

The Company continues to develop and commercialize future products and, consequently, it will need to generate additional revenues to achieve future profitability and may need to raise additional equity or debt financing. If the Company raises additional funds by issuing equity securities, its stockholders would experience dilution. Additional debt financing, if available, may involve covenants restricting its operations or its ability to incur additional debt. Any additional debt financing or additional equity that the Company raises may contain terms that are not favorable to it or its stockholders and requires significant debt service payments, which diverts resources from other activities. Additional financing may not be available at all, or in amounts or on terms acceptable to the Company. If the Company is unable to obtain additional financing, it may be required to delay the development and commercialization of its products and significantly scale back its business and operations.

On August 8, 2017, the Company entered into a debt financing agreement with OrbiMed Royalty Opportunities II, LP (“OrbiMed”) pursuant to a senior secured term loan facility (the “2017 Term Loan”). The 2017 Term Loan has a maximum borrowing capacity of $100.0 million, of which the Company borrowed $75.0 million on the closing date of August 8, 2017. The remaining $25.0 million is available to be borrowed at the Company’s option at any time through December 31, 2018, subject to standard conditions. The amounts borrowed under the 2017 Term Loan will primarily be used for general corporate purposes and to fund and support the Company’s business and operations. Interest will accrue on the outstanding balance of the loan at a rate equal to the sum of (i) 8.75% plus (ii) the higher of 1.00% or LIBOR. The 2017 Term Loan has an eighty-four month term and will mature in August 2024. The Company will be required to make interest payments over the term of the loan, with repayment of the full outstanding balance on the maturity date. The Company’s obligations under the 2017 Term Loan are secured by substantially all of the Company’s assets, including its intellectual property, subject to certain customary exceptions. As a fee in consideration of OrbiMed’s funding commitment, the Company issued 300,000 shares of its common stock to OrbiMed on August 14, 2017.

Based on the Company’s current business plan, the Company believes that its existing cash and marketable securities will be sufficient to meet its anticipated cash requirements for at least 12 months after November 8, 2017.

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 value of common stock and warrants, 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, including contractual terms and statutory limits; 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) and the Company currently carries its warrants at fair value according to the fair value measurement guidance.

Table of Contents

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 cash deposits held to secure commercial letters of credit issued by financial institutions, and the balance was insignificant as of September 30, 2017. 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 the Company’s 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 the Company’s 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 the Company’s invoices are collected. Payers may also withhold payments and request refunds of prior payments if the payer asserts that the Company has not performed 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 and nine months ended September 30, 2017, there were no customers exceeding 10% of total revenues on an individual basis. One customer accounted for 13% of total revenues for the three months ended September 30, 2016, and there were no customers exceeding 10% of total revenues on an individual basis for the nine months ended September 30, 2016. As of September 30, 2017, there were no customers with an outstanding balance exceeding 10% of net accounts receivable, and as of December 31, 2016, one customer, Bio-Reference, had an outstanding balance of approximately 52% of net accounts receivable, which was collected in full by the Company in February 2017.

Revenue Recognition

The Company generally bills an insurance carrier, a clinic or a patient for tests it sells upon delivery of the test results. 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. 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 other adjustments such as reserves for retractions and refunds 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. 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

Table of Contents

the insurance carrier, or if the tests were not previously authorized. From time to time, the Company receives 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, which is accounted for as reductions in revenues in the statement of operations and comprehensive loss. During the three months ended September 30, 2017, $3.7 million was reversed from this accrued liability and recognized as revenue.

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 recognizes revenue from its cloud-based distribution service offering, Constellation. The Company grants its licensees licenses to use certain of the Company’s proprietary intellectual property and the Company’s cloud-based software and provides other services to support the use of the Company's proprietary technology by 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 licensing and other revenues in the statements of operations and comprehensive loss.

The Company recognizes revenues from Evercord for the collection and storage of newborn cord blood and cord tissue units. Deliverables consist of: (i) the provision of a collection kit and the processing of newborn cord blood and cord tissue units, which are considered delivered at the beginning of the process (the “processing services”), with revenue for this deliverable recognized after the collection and successful processing of the cord blood and cord tissue units, and (ii) the storage of the cord blood and cord tissue units (the “storage services”), for either an annual fee or a prepayment covering an extended period or the lifetime of the newborn donor, with revenue for this deliverable recognized ratably over the applicable storage period. The Company bundles its processing services together with the first year of storage, and each of them has its own standalone value to customers, and therefore, represents a separate deliverable. The selling price for the processing services and the storage services are estimated based on the best estimate of selling price because the Company does not have vendor-specific objective evidence or third-party evidence of selling price for these elements. Evercord revenues are reported in licensing and other revenues in the statements of operations and comprehensive loss.

Cost of Product Revenues

The components of cost of product revenues are material and service costs, personnel costs, including stock-based compensation expense, equipment and infrastructure expenses associated with testing samples, electronic medical record,

Table of Contents

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 the performance of diagnostic services are recorded as tests are processed.

Cost of Licensing and Other Revenues

The components of cost of licensing and other revenues are material costs associated with test kits, engineering costs incurred by the research and development team to improve and maintain the Constellation software platform, and amortization of Constellation software development costs. Costs also include collection kits consumed during the processing of cord blood samples, processing service and storage of the cord blood samples, and freight charged to transport the samples to the storage facility.

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 and comprehensive loss 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 term 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 term 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 term 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 term. The expected dividend assumption was based on the Company's history and expectation of dividend payouts.

Starting January 1, 2016, the Company began using a different approach to estimate the expected term of its stock option awards, which involves calculating the average of (1) its employees’ historical stock option exercise behavior, and (2) the weighted-average of the time-to-vesting and the total contractual life of the options. The Company applied this change in methodology prospectively and accounted for it as a change in accounting estimate.

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 in the statements of operations and comprehensive loss. 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

Table of Contents

software held for internal use was $2.5 million and $1.3 million as of September 30, 2017 and December 31, 2016, respectively. Amortized expense for amounts previously capitalized for both the three months ended September 30, 2017 and 2016 was $0.3 million and $0.2 million, respectively. Amortized expense for amounts previously capitalized for the nine months ended September 30, 2017 and 2016 was $0.7 million and $0.4 million, respectively.

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,
	2016		Increase		Adjustment		2017
	(in thousands)
Unrealized (loss) gain on available-for-sale securities, net of tax	$	(725)	$	274	$	55	$	(396)
Total accumulated other comprehensive (loss) income, net of tax	$	(725)	$	274	$	55	$	(396)

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, outstanding common stock options, RSUs, ESPP, unvested shares subject to repurchase, and warrants are considered potential dilutive shares but are excluded from this calculation as the result becomes anti-dilutive, unless the consideration of any one of them gives a dilutive effect.

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.

Impairment of Long-lived Assets

The Company periodically evaluates the carrying value of its long-lived assets for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The Company then compares the carrying amount of the long-lived assets with the future net undiscounted cash flows expected to be generated by such asset. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value determined using discounted estimates of future cash flows. See Note 5 for more detail regarding assets impairment.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“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.

Recently Adopted Accounting Pronouncements

Table of Contents

In July 2015, the FASB 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 Company adopted ASU 2015-11 in the first quarter of 2017, and the adoption did not have a material impact on its financial statements and related disclosures.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which simplifies the presentation of deferred taxes by requiring that deferred tax assets and liabilities be presented as noncurrent on the balance sheet. The Company adopted ASU 2015-17 prospectively in the first quarter of 2017, which did not result in a material impact on its financial statements as a full valuation allowance has been reserved against the deferred tax assets and liabilities on the Company’s balance sheet as of September 30, 2017.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The new guidance requires any excess tax benefits (“windfalls”) and tax deficiencies (“shortfalls”) associated with vested or settled share-based awards to be recognized in the income statement rather than additional paid-in capital, which is to be applied prospectively. Further, windfalls will be required to be presented as an operating activity rather than as an outflow from operating activity and an inflow to financing activity, as required by the existing guidance. The Company adopted this new presentation guidance prospectively in the first quarter of 2017, which did not result in a material impact to its financial statements as a full valuation allowance has been reserved against the deferred tax assets and liabilities due to significant losses incurred since the Company’s inception. Therefore, there is no cumulative-effect adjustment required upon adoption of this new guidance. In addition, ASU 2016-09 allows entities to withhold tax equivalent shares up to the employees’ maximum individual tax rate in the relevant jurisdiction without having to account for the award as a liability-based award, and this guidance is to be applied using the modified retrospective approach, with a cumulative-effect adjustment to opening retained earnings. This new guidance is not applicable to the Company as it does not have a practice of withholding shares nor offering net-share settlement, and the Company does not withhold taxes exceeding its minimum statutory tax rate. ASU 2016-09 also permits forfeitures to be either estimated, as required by the existing guidance, or recognized when they occur. The change in the accounting for forfeitures is required to be applied using a modified retrospective approach, with a cumulative-effect adjustment to opening retained earnings. Upon adoption of this new guidance in the first quarter of 2017, the Company made an accounting policy election to continue estimating forfeitures as required by the existing guidance, which did not result in a cumulative-effect adjustment.

New Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued Accounting Standards Update No. 2014‑09, Revenue from Contracts with Customers (“ASU 2014‑09”) to provide guidance on revenue recognition. To date, the Company’s revenues have been derived primarily from contracts with insurance carriers, patients, clinics and licensing arrangements. Approximately 84% of the Company’s revenues are recognized on cash basis, and based on the Company’s preliminary assessment, this portion of revenues may be recognized at an earlier date than in the period of actual cash receipt. Consideration is received from either patients, clinics, or insurance carriers and/or any combination of the three, and licensees. Some of these arrangements, whether sell-in or sell-through, have similar characteristics and are being evaluated collectively as a portfolio under the five-step process prescribed by the new revenue standard. Currently, the Company has begun to perform preliminary analysis on its contracts with in-network and out-of-network insurance carriers, and estimates that the impact would be material upon adoption of ASU 2014-09. This new guidance will be effective for the Company in the first quarter of 2018, with early adoption permitted starting the first quarter of 2017. Upon adoption, ASU 2014-09 can be applied retrospectively to all periods presented or using the modified retrospective approach, which requires a cumulative-effect adjustment to be recorded in the opening balance of retained earnings only in the most current period presented. The Company has not yet determined which method will be used upon adoption, and will plan on adopting the new guidance in the first quarter of 2018.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be

Table of Contents

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 2016-02 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 expects that the adoption of ASU 2016-02 will increase its lease assets and correspondingly increase its lease liabilities in its financial statements.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the Emerging Issues Task Force) (“ASU 2016-15”). 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 does not expect the adoption of this new guidance to have a material impact on its financial statements.

In November 2016, the FASB issued Accounting Standards Update No. 2016-18 (“ASU 2016-08”), Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). The purpose of ASU 2016-18 is to eliminate the diversity in classifying and presenting changes in restricted cash in the statement of cash flows. The new guidance requires restricted cash to be combined with cash and cash equivalents when reconciling the beginning and ending balances of cash on the statement of cash flows, thereby no longer requiring transactions such as transfers between restricted and unrestricted cash to be treated as a cash flow activity. Further, the new guidance requires the nature of the restrictions to be disclosed, as well as a reconciliation between the balance sheet and the statement of cash flows on how restricted and unrestricted cash are segregated. The new guidance will be effective for the Company in the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, with early adoption permitted. The Company does not expect the adoption of this new guidance to have a material impact on its financial statements.

In May 2017, the FASB issued Accounting Standards Update No. 2017-09 (“ASU 2017-09”), Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. The purpose of this ASU is to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The new guidance will be effective for the Company in the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, with early adoption permitted. The Company is currently evaluating the impact of adopting ASU 2017-09 on its financial statements.

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.

Table of Contents

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, 2017								December 31, 2016
	Level I		Level II		Level III		Total		Level I		Level II		Level III		Total
	(in thousands)
Financial Assets:
Money market deposits	$	286	$	—	$	—	$	286	$	10,777	$	—	$	—	$	10,777
U.S. Treasury securities		84,279		—		—		84,279		57,442		—		—		57,442
U.S. agency securities		—		38,970		—		38,970		—		56,114		—		56,114
Municipal securities		—		11,768		—		11,768		—		17,304		—		17,304
Total financial assets	$	84,565	$	50,738	$	—	$	135,303	$	68,219	$	73,418	$	—	$	141,637

Current Liabilities:
Warrants	$	—	$	—	$	4,189	$	4,189	$	—	$	—	$	3,792	$	3,792
Total financial liabilities	$	—	$	—	$	4,189	$	4,189	$	—	$	—	$	3,792	$	3,792

During the three and nine months ended September 30, 2017, 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. 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, 2017:


	Warrants
	(in thousands)
Balance at December 31, 2016	$	3,792
Change in fair value		397
Balance at September 30, 2017	$	4,189

Table of Contents

Warrants

The significant unobservable inputs used in the fair value of warrants are derived from the Company's common stock valuation that is based on inputs from a Black-Scholes option-pricing model, with the expected term of 5.5 years, risk-free interest rate of 1.98%, and market volatility of 61.8% 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.

4. Financial Instruments

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


	September 30, 2017								December 31, 2016
	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	$	286	$	—	$	—	$	286	$	10,777	$	—	$	—	$	10,777
U.S. Treasury securities		84,550		8		(279)		84,279		57,846		—		(404)		57,442
U.S. agency securities		39,106		—		(136)		38,970		56,261		—		(147)		56,114
Municipal securities		11,757		15		(4)		11,768		17,478		—		(174)		17,304
Total	$	135,699	$	23	$	(419)	$	135,303	$	142,362	$	—	$	(725)	$	141,637

Classified as:
Cash equivalents							$	286							$	10,777
Short-term investments								135,017								130,860
Total							$	135,303							$	141,637

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 and nine months ended September 30, 2017, the Company had immaterial realized gains and losses. 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, 2017, the Company has 15 investments in an unrealized loss position in its portfolio. The Company earned interest income of $0.3 million and $0.8 million during the three and nine months ended September 30, 2017, respectively.

Table of Contents

The following table summarizes the Company’s portfolio of available-for-sale securities by contractual maturity as of September 30, 2017:


	September 30, 2017
	Amortized Cost		Fair Value
	(in thousands)
Less than one year	$	86,061	$	85,999
Greater than one year but less than five years		49,352		49,018
Total	$	135,413	$	135,017

5. Balance Sheet Components

Property and Equipment, net

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


		September 30,		December 31,
	Useful Life	2017		2016
		(in thousands)
Machinery and equipment	3-5 years	$	31,515	$	27,303
Furniture and fixtures	3 years		1,216		1,087
Computer equipment	3 years		1,951		861
Capitalized software held for internal use	3 years		4,081		2,172
Leasehold improvements	Lesser of useful life or lease term		10,668		10,444
Construction-in-process			6,149		9,759
			55,580		51,626
Less: Accumulated depreciation and amortization			(25,163)		(19,337)
Total Property and Equipment, net		$	30,417	$	32,289

During the nine months ended September 30, 2017, the Company recorded an asset impairment charge of $0.6 million in cost of product revenues in the statements of operations and comprehensive loss. This charge was recorded following an impairment analysis completed in the fourth quarter of 2016 on certain sequencing and automation equipment whose service lives were determined to be significantly shorter than initially expected. Those equipment were completely phased out in January 2017 as the Company began its transition to the next generation of sequencing and automation equipment to help streamline its production workflows.

Other Assets

In April 2016, the Company entered into a four-year agreement with a health 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, 2017 and December 31, 2016, $2.0 million and $2.6 million of deferred costs related to the total consideration paid were included in other long-term assets, respectively. 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, 2017, the Company amortized $0.2 million and $0.6 million of such costs, respectively, which was recorded as a reduction of product revenue in the statements of operations and comprehensive loss.

In August 2017, the Company entered into the 2017 Term Loan with OrbiMed and issued 300,000 shares of its common stock in exchange for OrbiMed’s initial and remaining funding commitments (as described in Note 8). The consideration had a fair value of $2.4 million and is accounted for as a debt discount. The Company has classified $1.8 million of the debt discount as a direct reduction from the outstanding debt balance, while $0.6 million remains in

Table of Contents

noncurrent assets for the unused borrowing capacity of $25.0 million. The debt discount is being amortized on a straight-line basis over the term of the loan. For the three months ended September 30, 2017, amortization of the debt discount was insignificant. As of September 30, 2017, total unamortized debt discount was $0.6 million.

Accrued Compensation

The Company’s accrued compensation consisted of the following:


	September 30,		December 31,
	2017		2016
	(in thousands)
Accrued paid time off	$	1,801	$	1,892
Accrued commissions		2,951		3,868
Accrued bonuses		1,950		2,387
Other accrued compensation		2,726		2,920
Total accrued compensation	$	9,428	$	11,067

Other Accrued Liabilities

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


	September 30,		December 31,
	2017		2016
	(in thousands)
Reserves for refunds to insurance carriers	$	8,138	$	7,535
Accrued charges for outsourced testing		6,033		3,261
Testing and laboratory materials from suppliers		1,151		543
Other accrued expenses		3,466		4,521
Marketing and corporate affairs		1,005		202
Legal, audit and consulting fees		289		180
Accrued shipping charges		370		467
Sales tax payable		351		459
Accrued specimen service fees		958		469
Accrued rent		766		195
Clinical trials and studies		495		388
Leasehold improvement projects in progress		—		1,659
Total other accrued liabilities	$	23,022	$	19,879

6. Commitments and Contingencies

Operating Leases

As of September 30, 2017, the Company leases office facilities under non‑cancelable operating lease agreements. The Company currently occupies approximately 104,000 square feet of laboratory and office space at its San Carlos, California corporate headquarters pursuant to a lease that it directly entered into with its landlord in October 2016. This lease covers two office spaces (the “First Space” and the “Second Space”). The First Space covers approximately 88,000 square feet at a base rent of $309,372 per month. The Second Space covers approximately 16,000 square feet at a base rent of $60,730 per month. The Company paid a security deposit totaling $0.7 million on this lease. The term of this lease is approximately eighty-four months and expires in October 2023.

The Company terminated the previous sublease of the First Space (as defined above), which was then separated into two subleases with two separate lessors. One sublease covered approximately 61,000 square feet beginning January 2013, which was secured by a $0.8 million letter of credit in favor of the lessor (as described in Note 2 under Restricted

Table of Contents

Cash) and terminated in October 2016. The other sublease covered approximately 27,000 square feet beginning March 2014, which was secured by a $0.3 million letter of credit in favor of the lessor and terminated in January 2017. As of January 31, 2017, the $0.3 million letter of credit expired, and its associated restricted cash balance was released. The $0.8 million letter of credit expired in July 2017, which accordingly released its associated restricted cash balance.

In October 2016, the Company entered into a sublease for additional office space that covers approximately 13,000 square feet to accommodate its sales and marketing team. The lease term of the additional space began in November 2016 and carried a monthly base rent of $49,140, subject to an annual increase of 3%, with a security deposit of $0.1 million. The term of this sublease is approximately twenty-eight months, with the expiration date in February 2019.

In October 2015, the Company’s subsidiary entered into a one-year lease agreement for temporary office space in Austin, Texas. The property carried 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 twelfth month. This lease expired in October 2016. The terms of the lease included a $12,900 security deposit, which was refunded by the landlord to the Company in June 2017.

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 beginning in December 2015 and expiring in November 2026 with monthly payments beginning in December 2016, increasing from $0.1 million to $0.2 million. Pursuant to the terms of the lease, the subsidiary has paid a security deposit of $0.4 million, and the landlord allotted the subsidiary an allowance for leasehold improvements of up to $7.8 million. As of September 30, 2017, the full amount of the allowance has been reimbursed by the landlord.

The future annual minimum lease payments under all non-cancelable operating leases as of September 30, 2017 are as follows:


	Operating Leases
	(in thousands)
Year ending December 31:
2017 (remaining 3 months)	$	1,842
2018		8,035
2019		8,548
2020		8,675
2021		8,913
2022 and thereafter		23,897
Total future minimum lease payments	$	59,910

Rent expense for the three months ended September 30, 2017 and 2016 was $1.7 million and $1.3 million, respectively, and $5.1 million and $3.9 million for the nine months ended September 30, 2017 and 2016, 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 prosecuting and defending its current litigation matters. 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.

Table of Contents

On each of February 17, 2016, March 10, 2016, March 28, 2016 and April 4, 2016, 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, its directors, certain of its officers and 5% stockholders and their affiliates, and each of the underwriters of the Company’s 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 “’33 Act”). 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 back to the San Mateo Superior Court. The Company has appealed the remand and discovery has been stayed, or held, pending the appeal. The Company also filed a demurrer, or a request for dismissal as a matter of law, in the San Mateo Superior Court, which was granted on October 23, 2017. The San Mateo Superior Court demurred the claims under Sections 12(a)(2) and 15 of the Securities Act of 1933, as amended, without leave to re-file. The San Mateo Superior Court granted the demurrer as to Section 11 of the Act with leave to re-file prior to November 24, 2017. Plaintiffs have not-refiled, but if they do, the Company intends to defend the matter vigorously, but cannot provide any assurance as to the ultimate outcome or that an adverse resolution would not have a material adverse effect on its financial condition and results of operations. The Company is unable to predict the ultimate outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

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, by a patient alleging that Natera failed to perform a carrier screening test that was ordered. The complaint seeks compensatory damages. This matter is in the discovery stage. On May 26, 2017, the Company filed a motion for summary judgment, which was denied. The matter is set for trial in March 2018. The Company intends to vigorously defend against the claims in this lawsuit, and assert any counterclaims that may be available to it. The Company cannot provide any assurance as to the ultimate outcome or that an adverse resolution of this lawsuit would not have a material adverse effect on its financial condition and results of operations. In light of, among other things, the early stage of the litigation, the Company is unable to predict the outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

On December 12, 2015, the Company received a civil investigative demand from the United States Department of Justice in connection with what it understands to be a qui tam action related to the billing of some of its testing. The Company has produced documents in response to the demand. An adverse ruling in this proceeding could require the Company to pay treble damages, civil penalties, and attorneys’ fees, costs and expenses, which could materially and adversely affect its business, financial condition and results of operations. The Company is unable to predict the outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

Director and Officer Indemnifications

As permitted under Delaware law, and as set forth in the Company’s Certificate of Incorporation and its Bylaws, the Company indemnifies its directors, executive officers, other officers, employees and other agents for certain events or occurrences that may arise while in such capacity. The maximum potential amount of future payments the Company could be required to make under this indemnification is unlimited; however, the Company has insurance policies that may limit its exposure and may enable it to recover a portion of any future amounts paid. Assuming the applicability of coverage, the willingness of the insurer to assume coverage, and subject to certain retention, loss limits and other policy provisions, the Company believes any obligations under this indemnification would not be material, other than an initial $1.5 million for securities related claims and $0.3 million for commercial general liability claims. However, no assurances can be given that the covering insurers will not attempt to dispute the validity, applicability, or amount of coverage without expensive litigation against these insurers, in which case the Company may incur substantial liabilities as a result of these indemnification obligations.

Table of Contents

Third-Party Payer Reimbursement Audits

Three third-party payers have alleged that they have overpaid the Company, and demanded recoupment of the alleged overpayments. The Company disagrees with the contentions.

Contractual Commitments

As of September 30, 2017, the Company has non-cancelable contractual commitments with a supplier for approximately $6.7 million and other material supplier commitments for approximately $2.1 million for inventory material used in the laboratory testing process.

As of September 30, 2017, the Company has a non-cancelable license agreement with a vendor for approximately $2.0 million. This represents binding and remaining commitments with the vendor through December 31, 2019.

As of September 30, 2017, the Company has non-cancelable contractual commitments with a vendor for biological sample processing and storage totaling approximately $2.6 million. This represents binding and remaining commitments with the vendor through December 31, 2021.

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, as amended, 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 IPO on July 2, 2015. The Company reserved 3,451,495 shares of its common stock for issuance under the 2015 Plan; in addition, the Company 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.

Performance-based Awards

In June 2017, the Board approved a stock option grant of 425,000 shares to the Company’s chief executive officer, of which 200,000 shares are performance-based options. The vesting of these performance-based options is contingent upon the completion of requisite service for the next three years and the achievement of certain milestones within such time period. The milestones are (i) to successfully secure a specified strategic arrangement, at which point 50,000 shares will begin vesting over one year in equal quarterly installments, (ii) to successfully secure a specified licensing arrangement, at which point 75,000 shares will begin vesting over one year in equal quarterly installments, and (iii) to successfully secure specified licensing arrangements related to oncology, at which point 75,000 shares will begin vesting over one year in equal quarterly installments. Each milestone is independent of the other.

For the three and nine months ended September 30, 2017, the Company did not recognize any compensation expense associated with the performance-based options since none of the milestones were achieved or were probable of being achieved.

Table of Contents

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 IPO on July 2, 2015. Under the ESPP, employees may purchase the Company’s 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.

The first offering period of fiscal year 2017 started on November 1, 2016 and ended April 30, 2017, and 211,729 shares were purchased at the end of this offering period for total proceeds of $1.5 million. The second offering period of fiscal year 2017 started on May 1, 2017 and will end on October 31, 2017. As of September 30, 2017, no shares had been purchased in this offering period.

Stock Options

The following table summarizes option activity for the nine months ended September 30, 2017:


	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, 2016	4,115	9,043	$	5.72	7.55	$	55,396
Additional shares authorized	2,107	—
Options granted	(1,921)	1,921	$	10.41
Options exercised	—	(474)	$	3.87
Options forfeited/cancelled	531	(531)	$	10.45
Balance at September 30, 2017	4,832	9,959	$	6.46	7.27	$	64,602
Exercisable at September 30, 2017		5,498	$	4.08	6.09	$	48,763
Vested and expected to vest at September 30, 2017		9,536	$	6.33	7.21	$	63,102

Restricted Stock Awards

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

Table of Contents

Restricted Stock Units

Starting April 2016, the Company began granting RSUs to its employees from the 2015 Plan. The following table summarizes RSU activity for the nine months ended September 30, 2017:



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

Balance at December 31, 2016	159	$	9.80
Granted	313	$	10.39
Vested	(57)	$	9.70
Canceled/forfeited	(36)	$	10.09
Balance at September 30, 2017	379	$	10.28

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, 2017 and 2016.


	Three months ended September 30,
	2017						2016
	Employee		Non-Employee		Total		Employee		Non-Employee		Total
	(in thousands)
Cost of revenues	$	138	$	9	$	147	$	164	$	(4)	$	160
Research and development		943		—		943		784		(1)		783
Selling, general and administrative		1,894		2		1,896		1,716		14		1,730
Total	$	2,975	$	11	$	2,986	$	2,664	$	9	$	2,673


	Nine months ended September 30,
	2017						2016
	Employee		Non-Employee		Total		Employee		Non-Employee		Total

	(in thousands)
Cost of revenues	$	420	$	10	$	430	$	479	$	3	$	482
Research and development		2,323		—		2,323		2,105		(1)		2,104
Selling, general and administrative		5,650		3		5,653		5,117		262		5,379
Total	$	8,393	$	13	$	8,406	$	7,701	$	264	$	7,965

As of September 30, 2017, approximately $21.3 million of unrecognized compensation expense, adjusted for estimated forfeitures, related to unvested option awards and RSUs will be recognized over a weighted‑average period of approximately 2.7 years.

Table of Contents

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,
	2017					2016					2017					2016
Expected term (years)				5.2					5.2		5.1		—	5.2		5.1		—	5.2
Expected volatility	62.3	%	—	62.5	%	69.0	%	—	72.5	%	62.3	%	—	62.9	%	68.5	%	—	72.5	%
Expected dividend rate				0	%				0	%				0	%				0	%
Risk-free interest rate	1.67	%	—	1.90	%	0.97	%	—	1.12	%	1.67	%	—	1.90	%	0.97	%	—	1.24	%

Valuation of Stock Option Grants to Non-Employees

As of September 30, 2017, total options outstanding include 136,046 shares of option awards that were granted to non-employees, of which 5,166 shares are unvested. Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock option is earned and the services are rendered. The Company believes that the estimated fair value of the stock options is more readily measurable than the fair value of the services rendered. The fair value of the stock options granted to non-employees is calculated at each reporting date using the Black-Scholes options-pricing model with the following assumptions:


	Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017					2016
Expected term (years)		2.7			2.8					2.7		2.8		—	3.2
Expected volatility		51.3	%		50.9	%	51.3	%	—	52.2	%	50.9	%	—	72.6	%
Expected dividend rate		0	%		0	%				0	%				0	%
Risk-free interest rate		1.58	%		0.85	%	1.42	%	—	1.58	%	0.68	%	—	0.90	%

Expected Term: The expected term of options represents the period of time that options are expected to be outstanding. For granted “at-the-money” stock options, the Company estimated the expected term by using the simplified method up until December 31, 2015, which involved calculating the average of the time-to-vesting and the total contractual life of the options. Starting January 1, 2016, the Company uses a different approach by calculating the average of (1) its employees’ historical stock options exercise behavior, and (2) the weighted-average of the time-to-vesting and the total contractual life of the options. For stock options that are not granted “at-the-money,” the Company uses the binomial lattice model to calculate the expected term.

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.

Table of Contents

8. Debt

Credit Line Agreement

In September 2015, the Company entered into a 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 Credit Line bears interest at 30-day LIBOR plus 0.65%. 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.

In November 2015, the Company borrowed an additional $10.0 million from the Credit Line to provide working capital, which increased the total principal amount outstanding to $42.0 million. In June 2016, the Company borrowed an additional $8.0 million and repaid $1.0 million on the Credit Line, thereby increasing the total principal amount outstanding to $49.0 million, with accrued interest of $0.6 million as of December 31, 2016. For the nine months ended September 30, 2017, $0.7 million additional interest was accrued, and the Company has made interest payments of $0.2 million. As of September 30, 2017, interest accrued was $1.1 million, and the total principal amount outstanding with accrued interest was $50.1 million.

2017 Term Loan

In August 2017, the Company entered into the 2017 Term Loan with OrbiMed, which has a maximum borrowing capacity of $100.0 million. On the closing date of August 8, 2017, the Company borrowed $75.0 million, with the remaining $25.0 million available to borrow at the Company’s option at any time through December 31, 2018, subject to standard conditions. The amounts borrowed under 2017 Term Loan will primarily be used for general corporate purposes and to fund and support the Company’s business and operations. Interest is accrued on the outstanding balance of the loan at a rate equal to the sum of (i) 8.75% plus (ii) the higher of 1.00% or LIBOR. The 2017 Term Loan has an eighty-four month term and will mature in August 2024. The Company is required to make interest payments on a quarterly basis, with repayment of the full outstanding balance on the maturity date. The Company’s obligations under the 2017 Term Loan are secured by substantially all of its assets, including its intellectual property, subject to certain customary exceptions.

The 2017 Term Loan contains customary affirmative and negative covenants including financial information maintenance covenants, indebtedness limitation covenants, minimum net revenues covenants, and investment covenants. It also includes standard events of default such as payment defaults and nonperformance of obligations and covenants described above. Upon an event of default, an additional interest of 3.00% may be applied to the outstanding debt balance until such default is cured, and OrbiMed may declare all outstanding obligations immediately due and payable. As of September 30, 2017, the Company was in compliance with all of its covenants under the 2017 Term Loan.

The Company is allowed to voluntarily make prepayments on its outstanding debt balance either partially or in full. When prepayments are made, an additional prepayment premium will be applied to the outstanding principal amount at the time. The prepayment premium will gradually reduce from 12.5% to 2.5% over the term of the loan.

For the three months ended September 30, 2017, interest accrued on the 2017 Term Loan was $1.1 million, which was fully paid by the Company as of September 30, 2017. As of September 30, 2017, no principal repayment has been made as the Company is not required to repay the outstanding balance until August 2024.

On August 14, 2017, the Company paid OrbiMed a fee in consideration of providing the 2017 Term Loan by issuing 300,000 shares of its common stock. The fair value of the fee was $2.4 million, which was determined based on the Company’s stock price of $8.16 on August 8, 2017 and is accounted for as a debt discount to be amortized on a straight-line basis over the term of the loan. The Company has classified $1.8 million of the debt discount as a direct reduction from the outstanding debt balance of $75.0 million, while the remainder is reported in noncurrent assets (as described in Note 5). For the three months ended September 30, 2017, the amount of the debt discount amortized as interest expense

Table of Contents

in the statements of operations and comprehensive loss was insignificant. As of September 30, 2017, the amount of the unamortized debt discount was $1.8 million, and the net carrying amount of the debt was $73.2 million.

9. Warrants

In April 2014, the Company granted approximately 376,691 warrants to purchase common stock with an exercise price of $2.3229 per common share. The warrants were granted to ROS Acquisition Offshore LP in connection with a senior secured term loan that has since been repaid and expire on April 18, 2023. 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. As of September 30, 2017, these warrants remain exercisable for common stock.

10. Income Taxes

During the three and nine months ended September 30, 2017, the Company recorded total income tax expense of $0.2 million and $0.3 million, respectively. The Company provides testing to clinics and licenses the cloud-based software to its licensees that are based in a foreign country, which contributed to a foreign income tax expense of $62,000 and $0.2 million for the three and nine months ended September 30, 2017, respectively. State income tax expense of $0.1 million based on income was also recorded for both the three and nine months ended September 30, 2017. During the same period of the prior year, the Company recorded a foreign income tax expense of $0.1 million. The federal and state effective tax rate is approximately 37% before research and development credits and permanent adjustments including stock-based compensation and change in the fair value of warrants.

Due to the Company’s history of cumulative operating losses, the Company concluded that, after considering all the available objective evidence, it is not more likely than not that all of 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 subjected to a valuation allowance as of September 30, 2017. 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 $5.7 million and $4.3 million in unrecognized tax benefits at September 30, 2017 and December 31, 2016, 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, 2017, there were no accrued interest and penalties related to uncertain tax positions.

11. Net Loss per Share

Basic 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. Diluted net loss per share is computed by giving effect to all potentially dilutive common shares outstanding for the period. For purposes of this computation, outstanding common stock options, restricted stock units, unvested common shares subject to repurchase and warrants are considered to be common share equivalents. Common share equivalents are excluded from the computation in periods in which they have an anti-dilutive effect.

For the three and nine months ended September 30, 2017, the warrants were excluded from the computation of diluted net loss per share as the change in its fair value and assumed exercises yielded an anti-dilutive effect. Other potentially dilutive common share equivalents such as outstanding common stock options, restricted stock and unvested common shares subject to repurchase were not included in the computation of diluted net loss per share for all periods as they also gave an anti-dilutive effect, which represents a reduction of the net loss per share.

Table of Contents

The following table provides the basic and diluted net loss per share computations for the three and nine months ended September 30, 2017 and 2016.


	Three months ended				Nine months ended
	September 30,				September 30,
(in thousands, except per share data)	2017		2016		2017		2016

Numerator:
Net loss, basic and diluted	$	(27,119)	$	(26,017)	$	(90,812)	$	(57,858)

Denominator:
Weighted-average shares outstanding		53,447		52,012		53,100		51,422
Less: weighted-average unvested shares subject to repurchase		—		—		—		(121)
Weighted-average number of shares used in computing net loss per share, basic and diluted		53,447		52,012		53,100		51,301

Net loss per share, basic and diluted	$	(0.51)	$	(0.50)	$	(1.71)	$	(1.13)

The following table shows total outstanding potentially dilutive shares excluded from the computation of diluted loss per share as their effect would be anti-dilutive, as of September 30, 2017 and 2016:


	September 30,
	2017	2016
	(in thousands)
Options to purchase common stock	9,959	9,146
Warrants to purchase common stock	377	377
Restricted stock units	379	174
Employee stock purchase plan	201	145
	10,916	9,842

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)	2017		2016		2017		2016

United States	$	50,641	$	48,125	$	139,326	$	149,436
Americas, excluding U.S.		773		688		2,258		1,991
Europe, Middle East, India, Africa		3,444		3,223		10,280		11,122
Other		1,798		1,853		5,310		5,226
Total	$	56,656	$	53,889	$	157,174	$	167,775

Table of Contents

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 enable even wider adoption of our technology through a global cloud-based distribution model. We have launched eight 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. We also launched our Constellation software platform in May 2015. In April 2017, we launched EvercordTM, which is a newborn cord blood and tissue processing and storage service. In May 2017, we launched Vistara, which is a new single-gene mutations screening test performed to detect single-gene disorders. In August 2017, we launched SignateraTM, which is a circulating tumor DNA technology that analyzes and tracks mutations specific to an individual’s tumor, for research use only by oncology researchers and biopharmaceutical companies. During the year ended December 31, 2016, we processed greater than 447,000 tests, comprised of approximately 430,000 tests accessioned in our laboratory and 17,000 tests processed through our Constellation software platform, or Constellation units. During the nine months ended September 30, 2017, we processed approximately 377,500 tests, comprised of approximately 356,300 tests accessioned in our laboratory and 21,200 Constellation units. Over 331,000 Panorama tests were accessioned during the year ended December 31, 2016, and approximately 253,100 Panorama tests were accessioned during the nine months ended September 30, 2017. Our revenues have grown from $4.3 million in 2010 to $217.1 million in the year ended December 31, 2016. Our revenues declined to $157.2 million in the nine months ended September 30, 2017 from $167.8 million in the same period of the prior year.

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; Constellation in 2015; and Evercord, Vistara and Signatera in 2017.

In the nine months ended September 30, 2017 and year ended December 31, 2016, 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 and Vistara testing is performed by third-party laboratories. Our customers include independent laboratories, national and regional reference laboratories, medical centers and physician practices for our screening tests and individual patients and families for our Evercord cord blood and tissue service. 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 cases where we bill laboratory and distribution partners, our partners in turn bill clinics, patients and insurance payers. The large majority of our revenue comes from insurers. Insurers with which we have in-network contracts 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 majority of insurance providers provide positive NIPT coverage. As of September 30, 2017, we have in-network contracts with insurance providers that account for over 198 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

Table of Contents

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.

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 through this effort 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 processed approximately 377,500 tests during the nine months ended September 30, 2017, comprised of approximately 356,300 tests accessioned and 21,200 Constellation units, compared to approximately 330,100 tests processed during the nine months ended September 30, 2016, comprised of approximately 318,100 tests accessioned and 12,000 Constellation units. This increase in volume is primarily due to the commercial growth of our Panorama and HCS tests, and tests processed through our Constellation software platform that was launched in May 2015. The percent of our revenues attributable to our U.S. direct sales force for the nine months ended September 30, 2017 was 83%, up from 79% for the nine months ended September 30, 2016. The percent of our revenues attributable to U.S. laboratory partners for the nine months ended September 30, 2017 was 6%, which was a decrease from 11% for the nine months ended September 30, 2016, primarily as a result of our termination of a distribution agreement earlier in the year. 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, 2017 was 11%, which was flat when compared to the nine months ended September 30, 2016.

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 and commercialization 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 $3.6 million and $2.3 million in revenues from our licensing arrangements during the nine months ended September 30, 2017 and 2016, respectively. Revenues from the DDC arrangement commenced in the second quarter of 2014 and our revenues from other Constellation licensing arrangements commenced beginning in the fourth quarter of 2015.

In April 2017, we launched Evercord, which is a cord blood and cord tissue processing and storage service. Our U.S. direct sales force sells Evercord to the same OB/GYNs who prescribe and order Panorama and HCS, and our own inside sales force offers this product to our existing and past patients who have used our Panorama or HCS tests. Upon the launch of Evercord, we also entered into an agreement with an umbilical cord blood bank to perform processing and testing of cord blood and cord tissue units and store those units at a designated facility.

In May 2017, we launched Vistara, which is our new single-gene mutations screening test performed to detect single-gene disorders and offered as an option to patients. Upon the launch of Vistara, we entered into an agreement with a laboratory partner that runs the test to collaborate in improving test performance and to launch commercially.

In August 2017, we launched Signatera, which is a circulating tumor DNA technology that analyzes and tracks mutations specific to an individual’s tumor, for research use only by oncology researchers and biopharmaceutical companies.

Our revenues decreased to $157.2 million in the nine months ended September 30, 2017 from $167.8 million in the nine months ended September 30, 2016. Panorama revenues accounted for $100.0 million, or 64%, of our revenues for the nine months ended September 30, 2017 and $108.7 million, or 65%, of our revenues for the nine months ended

Table of Contents

September 30, 2016. HCS revenues accounted for $44.7 million, or 29%, of our revenues for the nine months ended September 30, 2017 and $46.9 million, or 28%, of our revenues for the nine months ended September 30, 2016. A significant proportion of our revenues in the nine months ended September 30, 2017 were derived from in-network payer contracts. In January 2017, we terminated our licensing and distribution agreement for Panorama with Bio-Reference. For the three and nine months ended September 30, 2017, there were no customers exceeding 10% of total revenue on an individual basis. For the three months ended September 30, 2016, Bio-Reference accounted for 13% of total revenues, and there were no customers exceeding 10% of total revenues on an individual basis for the nine months ended September 30, 2016. Sales of Panorama to Bio-Reference represented 7% of our revenues generated from Panorama in the nine months ended September 30, 2016. Revenues from customers outside the United States were $17.8 million and $18.3 million for the nine months ended September 30, 2017 and 2016, 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.

Our net losses for the nine months ended September 30, 2017 and 2016 were $90.8 million and $57.9 million, respectively. This included non-cash stock compensation expense of $8.4 million and $8.0 million for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, we had an accumulated deficit of $436.7 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 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 partners. We also have a cloud-based distribution model through licensees 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 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 are 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. We receive licensing revenue through the licensing and the provisioning of services to support the use of our proprietary technology with our cloud-based distribution model licensees. Licensing revenues are recognized when earned under the terms of the related agreements and are presented as Licensing and Other Revenues in the statements of operations and comprehensive loss.

We recognize revenues from Evercord for the collection and storage of newborn cord blood and cord tissue units. Deliverables consist of: (i) the provision of a collection kit and the processing of newborn cord blood and cord tissue units (the “processing services”), with revenue for this deliverable recognized after the collection and successful processing of

Table of Contents

the cord blood and cord tissue units, and (ii) the storage of the cord blood and cord tissue units (the “storage services”), for either an annual fee or a prepayment covering an extended period or the lifetime of the newborn donor, with revenue for this deliverable recognized ratably over the applicable storage period. We bundle our processing services together with first year storage, and each of them has its own standalone value to customers, and therefore, represents a separate deliverable. The selling price for the processing services and the storage services are estimated based on the best estimate of selling price because we do not have vendor specific objective evidence or third-party evidence of selling price for these elements. Evercord revenues are reported in Licensing and Other Revenues in the statements of operations and comprehensive loss.

Revenue recognized on a cash basis represented 83% and 81% of our revenues for the three months ended September 30, 2017 and 2016, respectively, and 84% and 85% of our revenues for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, we have 23 licensing and service arrangements with laboratories under our cloud-based distribution model. For the three and nine months ended September 30, 2017, we recognized revenue from nine 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 many third-party payers have begun to reimburse for this, and we believe that additional 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,” in part because there is currently limited published data on the performance of microdeletions screening tests. A new current procedure terminology, or CPT, code for microdeletions went into effect beginning January 1, 2017. We have experienced low average reimbursement rates thus far for microdeletions testing under this new code, and we expect that this new code will cause, at least in the near term, our microdeletions reimbursement to remain low, either due to reduced reimbursement, or third-party payers declining to reimburse. Any such decline in reimbursement would decrease our revenues. Our financial performance is also impacted by our having increased our 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 decreases accordingly. 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 Constellation, cloud-based software platform 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. However, cost of licensing and other revenues for the Constellation software platform are relatively low, and therefore, its associated gross margin is higher.

Cost of Product Revenues

The components of our cost of product revenues are material 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.

Table of Contents

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 accuracy 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. We have agreements with 23 laboratories and are in active discussions with many other potential licensees under this distribution model.

Cost of Licensing and Other Revenues

The components of our cost of licensing and other revenues are material costs associated with test kits, engineering costs incurred by our research and development team to improve and maintain our Constellation software platform, and amortization of Constellation software development costs. Cost of licensing and other revenues also include costs associated with Evercord, which is a cord blood and cord tissue processing and storage service. Such costs are related to collection kits consumed during the processing of cord blood samples, fees for the processing service and storage of the cord blood samples, and freight charged to transport the samples to the storage facility.

We consider our cost of licensing and other revenues for the Constellation software platform to be relatively low, and therefore we expect its associated gross margin to be higher. As we increase licensing of our cloud-based technology to our licensees, we expect cost of licensing and other revenues in absolute dollars to increase.

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 incurred in connection with us operating as a public company to begin generating at a steady rate, and 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 Credit Line and 2017 Term Loan, as well as the amortization of debt discount associated with the term loan.

Table of Contents

Interest and Other (Expense) Income, net

Interest and other (expense) income, net is from interest earned on our cash, realized gains on investments, foreign currency remeasurement gains, changes in the fair value of our warrants, and finance charges related to the unused borrowing capacity of our 2017 Term Loan.

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, stock-based compensation, and impairment of long-lived assets. There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2017 from those disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2017.

Results of operations

Comparison of the three months ended September 30, 2017 and 2016


	Three months ended
	September 30,				Change
	2017		2016		Amount		Percent
		(In thousands except percentage)
Revenues:
Product revenues	$	55,331	$	53,090	$	2,241	4.2	%
Licensing and other revenues		1,325		799		526	65.8
Total revenues		56,656		53,889		2,767	5.1
Cost and expenses:
Cost of product revenues		33,558		33,761		(203)	(0.6)
Cost of licensing and other revenues		1,054		500		554	110.8
Research and development		12,609		11,345		1,264	11.1
Selling, general and administrative		34,478		34,938		(460)	(1.3)
Total cost and expenses		81,699		80,544		1,155	1.4
Loss from operations		(25,043)		(26,655)		1,612	(6.0)
Interest expense		(1,477)		(146)		(1,331)	911.6
Interest and other (expense) income, net		(437)		887		(1,324)	(149.3)
Loss before income taxes		(26,957)		(25,914)		(1,043)	4.0
Income tax expense		(162)		(103)		(59)	57.3
Net loss	$	(27,119)	$	(26,017)	$	(1,102)	4.2	%

Revenues

Total revenues increased $2.8 million, or 5.1%, from the three months ended September 30, 2016 to the three months ended September 30, 2017. This was primarily due to an increase in volume of tests performed. The net increase of $2.2 million in product revenues was primarily driven by an increase in HCS revenues of $4.7 million, offset by a $2.4 million decrease in Panorama revenues and a $0.1 million decrease in other revenues. The growth in HCS revenues was

Table of Contents

the combined result of $4.1 million increased payments from insurance carriers and clinics due to higher test volume and $0.6 million of revenue recognized with the release of certain amounts previously held in reserves from third party payers. Panorama test volume grew slightly when compared to the same period of the prior year, whereas its reduced revenues of $6.8 million were the combined results of lower average selling price charged to our in-network payers, lower collections on our microdeletions screening, and partially caused by our termination of a distribution agreement earlier in the year. These were offset by $3.1 million of revenue recognized with the release of certain amounts previously held in reserves from third party payers, and $1.3 million of payments from insurance carriers resulting from higher test volume.

Licensing and other revenues increased by $0.5 million during the three months ended September 30, 2017 compared to the three months ended September 30, 2016 as we entered into additional licensing and service arrangements related to the Constellation software platform with our laboratory partners, and because of revenues recognized from Evercord, which is our cord blood and cord tissue processing and storage service, which we did not offer in 2016.

During the three months ended September 30, 2017, we processed approximately 130,400 tests, comprised of approximately 122,600 tests accessioned and 7,800 Constellation units. Approximately 85,100 Panorama tests and 32,800 HCS tests were accessioned during the three months ended September 30, 2017. We recognized revenue on approximately 78,700 tests, including approximately 56,400 Panorama tests and 19,900 HCS tests, in the three months ended September 30, 2017. Forty-seven percent of the 78,700 tests, including 50% of the 56,400 Panorama tests and 42% of the 19,900 HCS tests, were accessioned in the three months ended September 30, 2017, and the remainder were accessioned in prior periods. During the three months ended September 30, 2016, we processed approximately 113,500 tests, comprised of approximately 109,100 tests accessioned and 4,400 Constellation units. Approximately 84,400 Panorama tests and 20,500 HCS tests were accessioned during the three months ended September 30, 2016. We recognized revenue on approximately 67,500 tests, including approximately 56,000 Panorama tests and 9,700 HCS tests, in the three months ended September 30, 2016. Fifty-one percent of the 67,500 tests, including 53% of the 56,000 Panorama tests and 43% of the 9,700 HCS tests, were accessioned in the three months ended September 30, 2016 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 certain 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 percentage of revenue recognized from tests accessioned in the three months ended September 30, 2017 was 47%, compared to 51% in three months ended September 30, 2016.

Revenues from customers outside the United States were $6.0 million and $5.8 million for the three months ended September 30, 2017 and 2016, respectively.

Cost of product revenues

Cost of product revenues decreased $0.2 million, or 0.6%, during the three months ended September 30, 2017 compared to the three months ended September 30, 2016 primarily due to $4.3 million cost savings from Panorama test processing following our transition to Version 3 of Panorama, lower freight charges and overhead of $0.8 million, and a cost benefit resulting from a $0.2 million asset impairment charge recorded for our previous generation of automation and sequencing equipment in the same period of the prior year, offset by $4.9 million of additional costs incurred due to increased volume of HCS tests accessioned and material costs resulting from a higher number of other tests processed in the three months ended September 30, 2017 and inventory excess adjustments of $0.2 million. As a percentage of product revenues, cost of product revenues decreased 3.0% from 63.6% of revenues for the three months ended September 30, 2016 to 60.6% for the three months ended September 30, 2017.

Cost of licensing and other revenues

Cost of licensing and other revenues increased $0.6 million, or 110.8%, during the three months ended September 30, 2017 compared to the three months ended September 30, 2016 primarily due to the addition of our new product, Evercord. Such costs were related to collection kits consumed during the processing of cord blood samples, processing

Table of Contents

service and storage of the cord blood samples, and freight charged to transport the samples to the storage facility. In the three months ended September 30, 2017, $0.6 million of such costs were recorded in cost of licensing and other revenues.

Cost of licensing and other revenues also included costs associated with the improvement and maintenance of our Constellation software platform. In the three months ended September 30, 2017, engineering costs allocated to cost of licensing and other revenues, as well as the amortization of the Constellation software development and other material costs, remained flat when compared to the same period of the prior year.

Research and development

Research and development expenses increased $1.3 million, or 11.1%, during the three months ended September 30, 2017 compared to the three months ended September 30, 2016. The increase in research and development expenses was primarily attributable to a $0.7 million increase in salaries and employee benefits associated with headcount growth and bonuses accrued, which also caused a total of $0.4 million increase in facility-related costs and office expenses, along with higher rent and management fees charged for our headquarters in San Carlos, California. Expenses associated with ongoing clinical trials and laboratory supplies increased $0.6 million. Depreciation and overhead increased $0.4 million as a result of testing and validation performed on our next generation of sequencing and automation equipment, and in connection with HCS automation. These increases were offset by $0.9 million reduced spending on consulting fees.

Selling, general and administrative

Selling, general and administrative expenses decreased $0.4 million, or 1.3%, in the three months ended September 30, 2017 compared to the three months ended September 30, 2016. The decrease in selling, general and administrative expenses was primarily attributable to reduced spending of $1.4 million on sales and marketing related expenses as we scaled back on market research, public relations and promotional events, along with $0.2 million decrease in bonuses accrued and other corporate related expenses, offset by a $1.2 million increase in salaries and employee benefits associated with headcount growth and higher health insurance premiums charged by insurance carriers.

Interest expense

Interest expense increased $1.3 million in the three months ended September 30, 2017 when compared to the same period of the prior year. The increase was primarily due to $1.1 million of interest incurred and debt discount amortized from additional debt we borrowed in August 2017, and $0.2 million of interest charged at the variable interest rate on the Credit Line, which was higher in the three months ended September 30, 2017. See “Liquidity and Capital Resources—Credit Line Agreement.”

Interest and other (expense) income, net

Interest and other expense, net was $0.4 million for the three months ended September 30, 2017, compared to interest and other income of $0.9 million in the same period of the prior year, which represented a decrease of $1.3 million. The decrease was primarily due to an unfavorable movement on the change in the fair value of our warrant liability totaling $1.1 million, and a decrease in interest income and other expenses of approximately $0.2 million due to our reduced investment portfolio.

Table of Contents

Comparison of the nine months ended September 30, 2017 and 2016


	Nine Months Ended
	September 30,				Change
	2017		2016		Amount		Percent
		(In thousands except percentage)
Revenues:
Product revenues	$	153,520	$	165,457	$	(11,937)	(7.2)	%
Licensing and other revenues		3,654		2,318		1,336	57.6
Total revenues		157,174		167,775		(10,601)	(6.3)
Cost and expenses:
Cost of product revenues		100,355		97,074		3,281	3.4
Cost of licensing and other revenues		2,516		500		2,016	403.2
Research and development		37,045		30,403		6,642	21.8
Selling, general and administrative		106,369		98,573		7,796	7.9
Total cost and expenses		246,285		226,550		19,735	8.7
Loss from operations		(89,111)		(58,775)		(30,336)	51.6
Interest expense		(1,878)		(383)		(1,495)	390.3
Interest and other income		450		1,403		(953)	(67.9)
Loss before income taxes		(90,539)		(57,755)		(32,784)	56.8
Income tax expense		(273)		(103)		(170)	165.0
Net loss	$	(90,812)	$	(57,858)	$	(32,954)	57.0	%

Revenues

Total revenues decreased $10.6 million, or 6.3%, from the nine months ended September 30, 2016 to the nine months ended September 30, 2017. Product revenues decreased $11.9 million, or 7.2%, of which $8.8 million was related to Panorama revenues and $2.2 million was related to HCS revenues. While Panorama test volume grew compared to the same period of the prior year, the associated revenues declined $11.9 million due to combined effect of lower average selling price charged to our in-network payers, lower collections on our microdeletions screening, and partially resulting from our termination of a distribution agreement earlier in the year. These were offset by $3.1 million of revenue recognized with the release of certain amounts previously held in reserves from third party payers. The decrease in HCS revenues was comprised of $4.7 million of reduced insurance payments resulting from lower average selling price charged to our in-network payers, offset by an increase of $2.0 million associated with higher number of tests sold to clinics and laboratory partners and $0.6 million of revenue recognized with the release of certain amounts previously held in reserves from third party payers. Approximately 74% of our revenues during the nine months ended September 30, 2017 were derived from test volumes accessioned within the same quarter; the remaining revenues were derived from tests accessioned in prior periods.

Licensing and other revenues increased by $1.3 million during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 as we entered into additional licensing and service arrangements related to the Constellation software platform with our laboratory partners, and because of revenues recognized from Evercord, which is our cord blood and cord tissue processing and storage service, which we did not offer in 2016.

During the nine months ended September 30, 2017, we processed approximately 377,500 tests, comprised of approximately 356,300 tests accessioned and 21,200 Constellation units. Approximately 253,100 Panorama tests and 90,400 HCS tests were accessioned during the nine months ended September 30, 2017. We recognized revenue on approximately 202,300 tests, including approximately 148,300 Panorama tests and 47,700 HCS tests, in the nine months ended September 30, 2017. Seventy-four percent of the 202,300 tests, including 76% of the 148,300 Panorama tests and 72% of the 47,700 HCS tests, were accessioned in the nine months ended September 30, 2017, and the remainder were accessioned in prior periods. During the nine months ended September 30, 2016, we processed approximately 330,100 tests, comprised of approximately 318,100 tests accessioned and 12,000 Constellation units. Approximately 247,100 Panorama tests and 58,800 HCS tests were accessioned during the nine months ended September 30, 2016. We recognized revenue on approximately 158,500 tests, including approximately 129,800 Panorama tests and 23,400 HCS tests, in the

Table of Contents

nine months ended September 30, 2016. Seventy-seven percent of the 158,500 tests, including 78% of the 129,800 Panorama tests and 75% of the 23,400 HCS tests, were accessioned in the nine months ended September 30, 2016 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 certain 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 percentage of revenue recognized from tests accessioned in the nine months ended September 30, 2017 was 74%, compared to 77% in nine months ended September 30, 2016.

Revenues from customers outside the United States were $17.8 million and $18.3 million for the nine months ended September 30, 2017 and 2016, respectively.

Cost of product revenues

Cost of product revenues increased $3.3 million, or 3.4%, during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 due to $11.8 million of additional costs incurred by increased volume of HCS tests accessioned in the nine months ended September 30, 2017, higher freight charges and overhead of $1.0 million, an asset impairment charge and inventory excess adjustments of $1.0 million primarily related to the phasing out of our previous generation of automation and sequencing technology, a temporary increase in expenses and material costs caused by increased vendor materials qualification activities during the processing of Version 3 of Panorama tests, offset by $10.2 million cost savings from Panorama test processing following our transition to the next generation of automation and sequencing technology and lower material costs for other tests processed, and a cost benefit resulting from a $0.2 million asset impairment charge recorded for our previous generation of automation and sequencing equipment in the same period of the prior year. As a percentage of product revenues, cost of product revenues increased 6.7% from 58.7% for the nine months ended September 30, 2016 to 65.4% for the nine months ended September 30, 2017.

Cost of licensing and other revenues

Cost of licensing and other revenues increased $2.0 million during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 as we increased licensing of the cloud-based software product to our licensees and continued to improve and maintain our Constellation software platform. Costs allocated to Constellation software platform increased approximately $1.1 million, of which $0.8 million was related to engineering costs, and $0.3 million was related to the amortization of the Constellation software development and other material costs.

Cost of licensing and other revenues also included costs associated with our new product, Evercord. Such costs were related to materials consumed during the processing of cord blood samples, processing service and storage of the cord blood samples, and freight charged to transport the samples to the storage facility. In the nine months ended September 30, 2017, $0.9 million of such costs were recorded in cost of licensing and other revenues.

Research and development

Research and development expenses increased $6.6 million, or 21.8%, during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. The increase in research and development expenses was primarily attributable to merit salary adjustments and higher salaries and benefit costs of $3.1 million because of increased headcount, which also caused a total of $1.3 million increase in facility-related costs and office expenses as a result of expansion of our lease premises, along with higher rent and management fees charged for our headquarters in San Carlos, California. Expenses associated with ongoing clinical trials and laboratory supplies increased $1.7 million because of the launch of our oncology research project in August 2017. Depreciation and overhead increased $0.9 million as a result of testing and validation performed on our next generation of sequencing and automation equipment, and in connection with HCS automation. These were offset by a decrease in outside services of $0.5 million.

Table of Contents

Selling, general and administrative

Selling, general and administrative expenses increased $7.8 million, or 7.9%, in the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. The increase in selling, general and administrative expenses was primarily attributable to $8.0 million increase in salaries and employee benefits associated with headcount growth, merit salary adjustments, higher health insurance premiums charged by insurance carriers, and higher stock-based compensation expense from the new ESPP offered to our employees. Outside service costs increased a total of $1.0 million, which was comprised of an additional spending of $0.5 million on accounting and audit related fees primarily related to consultants hired for technical accounting and internal controls assessment projects, corporate tax related work and audit fees as a result of our annual audit and quarterly financial reviews, $0.8 million of legal fees paid for work related to corporate affairs and patented technology, $0.2 million from outsourcing our staff recruiting effort, offset by $0.5 million of reduced spending on temporary insurance billing staff. Facility-related and other corporate expenses increased $0.8 million as a result of higher spending on supplies, software subscription and increased depreciation expense on office equipment, along with higher rent and management fees charged for our headquarters in San Carlos, California. These increases were offset by reduced spending of $2.0 million on sales and marketing and travel expenses as we scaled back on speaker conferences, public relations and promotional events.

Interest expense

Interest expense increased $1.5 million in the nine months ended September 30, 2017 when compared to the same period of the prior year. The increase was primarily due to $1.1 million of interest incurred and debt discount amortized from additional debt we borrowed in August 2017, and $0.4 of interest charged at the variable interest rate on the Credit Line, which was higher in the nine months ended September 30, 2017. See “Liquidity and Capital Resources—Credit Line Agreement.”

Interest and other income

Interest and other income decreased $1.0 million for the nine months ended September 30, 2017 compared to the same period of the prior year primarily due to a $0.5 million unfavorable movement on the change in the fair value of our warrant liability and a decrease in interest income and other expenses of $0.5 million primarily attributable to our reduced investment portfolio.

Liquidity and Capital Resources

We have incurred net losses each year since our inception. For the nine months ended September 30, 2017, we had a net loss of $90.8 million, and we expect to incur additional losses in future periods. As of September 30, 2017, we had an accumulated deficit of $436.7 million. As of September 30, 2017, we had $11.2 million in cash and cash equivalents, $135.0 million in short-term investments, $50.1 million of outstanding balance of the Credit Line including accrued interest, and $73.2 million of net carrying amount of the 2017 Term Loan.

While we have introduced multiple products that are generating revenues, these revenues have not been sufficient to fund all operations. Accordingly, we have funded the portion of operating costs that exceeds revenues through a combination of equity issuances, debt issuances, and other financings. We expect to develop and commercialize future products and, consequently, we will need to generate additional revenues to achieve future profitability and may need to raise additional equity or debt financing. If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Additional debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any additional debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders and requires significant debt service payments, which diverts resources from other activities. Additional financing may not be available at all, or in amounts or on terms acceptable to us. If we are unable to obtain additional financing, we may be required to delay the development and commercialization of our products and significantly scale back our business and operations.

Table of Contents

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 12 months after November 8, 2017.

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.

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 currently bears interest at 30-day LIBOR plus 1.10%. 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.

In November 2015, we borrowed an additional $10.0 million from the Credit Line to provide working capital, which increased the total principal amount outstanding to $42.0 million. In June 2016, we borrowed an additional $8.0 million and repaid $1.0 million on the Credit Line, thereby increasing the total principal amount outstanding to $49.0 million, with accrued interest of $0.6 million as of December 31, 2016. As of September 30, 2017, interest accrued was $1.1 million, and the total principal amount outstanding with accrued interest was $50.1 million.

2017 Term Loan

In August 2017, we entered into the 2017 Term Loan with OrbiMed, which has a maximum borrowing capacity of $100.0 million. On the closing date of August 8, 2017, we borrowed $75.0 million, with the remaining $25.0 million available for borrowing at our option at any time through December 31, 2018, subject to standard conditions. The amounts borrowed under the 2017 Term Loan are primarily being used for general corporate purposes and to fund and support our business and operations. Interest is accrued on the outstanding balance of the loan at a rate equal to the sum of (i) 8.75% plus (ii) the higher of 1.00% or LIBOR. The 2017 Term Loan has an eighty-four month term and will mature in August 2024. We are required to make interest payments over the term of the loan, with repayment of the full outstanding balance on the maturity date. Our obligations under the 2017 Term Loan are secured by substantially all of our assets, including our intellectual property, subject to certain customary exceptions.

Table of Contents

Cash Flows

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


	Nine Months Ended
	September 30,
	2017		2016
	(In thousands)
Cash used in operating activities	$	(68,649)	$	(44,406)
Cash (used in) provided by investing activities		(13,733)		30,089
Cash provided by financing activities		78,337		10,692
Net decrease in cash		(4,045)		(3,625)
Cash at beginning of year		15,256		28,947
Cash at end of period	$	11,211	$	25,322

Cash Used in Operating Activities

Cash used in operating activities during the nine months ended September 30, 2017 was $68.7 million. The net loss of $90.8 million includes $17.6 million in non‑cash benefits resulting from $8.4 million of stock-based compensation expense, $5.3 million of depreciation and amortization, $0.7 million of premium amortization and discount accretion on investment securities, $1.8 million of accrued interest on our Credit Line and 2017 Term Loan, an asset impairment charge of $0.6 million recorded as a result of us entirely phasing out certain sequencing and automation equipment, a $0.4 million remeasurement loss on the change in the fair value of our warrant liability, and inventory excess adjustments of $0.4 million. Operating assets increased cash by $5.1 million primarily due to a $6.1 million decrease in accounts receivable, a $1.5 million decrease in restricted cash and other assets, and a $0.7 million decrease in prepaid and other current assets, offset by a $3.2 million increase in inventory. Operating liabilities reduced cash by $0.6 million primarily due to an increase in other accrued liabilities of $3.7 million, increases in deferred revenue and deferred rent of $1.8 million, offset by a decrease in accounts payable of $4.5 million and a decrease of accrued compensation of $1.6 million.

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 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) Provided by Investing Activities

Cash used in investing activities for the nine months ended September 30, 2017 totaled $13.7 million, which was comprised of $4.6 million in purchases of securities net of investment proceeds and the acquisition of $9.1 million of property and equipment, net of proceeds. Acquisitions of property and equipment are primarily related to the transition to our next generation automation and sequencing technology, purchases of computer hardware and software and costs capitalized for the development of our patient portal.

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.

Table of Contents

Cash Provided by Financing Activities

Cash provided by financing activities for the nine months ended September 30, 2017 totaled $78.3 million, which was comprised of $75.0 million in borrowings from our 2017 Term Loan we entered into in August 2017, and $3.3 million of proceeds from exercise of stock options and issuance of common stock under ESPP.

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.

Contractual Obligations and Other Commitments

See “Liquidity and Capital Resources” for a description of our contractual obligations under the Credit Agreement.

The following table summarizes our contractual obligations as of September 30, 2017:


	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	$	59,910	$	7,632	$	17,261	$	17,949	$	17,068
Short-term debt(1)		49,000		49,000		—		—		—
Interest on short-term debt(2)		1,097		1,097		—		—		—
Long-term debt(3)		75,000		—		—		—		75,000
Inventory purchase obligations(4)		8,770		8,770		—		—		—
Contractual obligations(5)		4,588		—		3,725		863		—
Total	$	198,365	$	66,499	$	20,986	$	18,812	$	92,068

(1)

Represents proceeds drawn from our Credit Line.

(2)

Represent our accrued interest as of September 30, 2017 on our Credit Line.

(3)

Represents proceeds from the 2017 Term Loan.

(4)

Represents material open inventory purchase orders in the aggregate with suppliers as of September 30, 2017, including a contractual commitment with Illumina, Inc. for $6.7 million for inventory material used in the laboratory testing process within the next 12 months.

(5)

Represents $2.6 million non-cancelable contractual commitments with a vendor for biological sample processing and storage through December 31, 2021, and $2.0 remaining commitments of a non-cancelable license agreement with a vendor until December 31, 2019.

Operating Lease Obligations

As of September 30, 2017, we lease office facilities under non‑cancelable operating lease agreements. We currently occupy approximately 104,000 square feet of laboratory and office space at our San Carlos, California corporate headquarters pursuant to a lease that we directly entered into with our landlord in October 2016. This lease covers two office spaces (the “First Space and the “Second Space”). The First Space covers approximately 88,000 square feet at a base rent of $309,372 per month. The Second Space covers approximately 16,000 square feet at a base rent of $60,730 per month. We paid a security deposit totaling $0.7 million on this lease. The term of this lease is approximately eighty-four months and expires in October 2023.

Table of Contents

We terminated the previous sublease of the First Space (as described above), which had been separated into two subleases with two separate lessors. One sublease covered approximately 61,000 square feet beginning January 2013, which was secured by a $0.8 million letter of credit (refer to Note 2 under Restricted Cash in the Notes to Unaudited Interim Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report) in favor of the lessor and terminated in October 2016. The other sublease covered approximately 27,000 square feet beginning March 2014, which was secured by a $0.3 million letter of credit in favor of the lessor and terminated in January 2017.

In October 2016, we entered into a sublease for additional office space that covers approximately 13,000 square feet to accommodate our sales and marketing team. The lease term of the additional space began in November 2016 and carried a monthly base rent of $49,140, subject to an annual increase of 3%, with a security deposit of $0.1 million. The term of this sublease is approximately twenty-eight months, with the expiration date in February 2019.

In October 2015, our subsidiary entered into a one-year lease agreement for temporary office space in Austin, Texas. The property carried 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. This lease expired in October 2016. The terms of the lease included a $12,900 security deposit, which was refunded by the landlord to us in June 2017.

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 and expiring in November 2026 with monthly rent payments beginning in December 2016, increasing from $0.1 million to $0.2 million. Pursuant to the terms of the lease, the subsidiary has paid a security deposit of $0.4 million, and the landlord allotted the subsidiary an allowance for leasehold improvements of up to $7.8 million. As of September 30, 2017, the full amount of the allowance has been reimbursed by the landlord.

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, 2017, we have contractual commitments with Illumina, Inc. and other material suppliers for approximately $6.7 million and $2.1 million, respectively, for inventory material used in the laboratory testing process. This represents binding and future minimum purchase obligations within the next 12 months.

Contractual Obligations

As of September 30, 2017, we have non-cancelable contractual commitments with a vendor for biological sample processing and storage totaling approximately $2.6 million. This represents our binding and remaining commitments with the vendor through December 31, 2021.

As of September 30, 2017, we have a non-cancelable agreement with a vendor for approximately $2.0 million. This represents binding and remaining commitments with the vendor through December 31, 2019.

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

Table of Contents

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 1.10%. The LIBOR rate is variable. Our 2017 Term Loan has an interest rate of three-month variable LIBOR plus 8.75%. An incremental change in the borrowing rate of 100 basis points would increase our annual interest expense by $1.3 million based on our $125.1 million gross debt outstanding, including principal and accrued interest as of September 30, 2017. We expect our annual interest expense to increase as a result of our 2017 Term Loan.

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 2017, our interest income would change by approximately $1.4 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, 2017.

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.

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, 2017. 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, 2017, 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.

Table of Contents

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.

For information regarding certain current legal proceedings, see “Note 6—Commitments and Contingencies—Legal Proceedings” in the Notes to Unaudited Interim Condensed Consolidated Financial Statements, which is incorporated herein by reference.

Table of Contents

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 and services in the future do not succeed, our business will be harmed.

For the three months ended September 30, 2017 and the year ended December 31, 2016, 63% and 66%, respectively, of our revenues were derived from sales of our NIPT, Panorama. Although we are growing our revenues from other products, in particular our Horizon carrier screen, 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, reimbursement for the average risk population and for microdeletions, and our ability 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, physicians may not recommend and order Panorama, and our laboratory distribution 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 it may be challenging for us 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;

if we are unable to demonstrate that Panorama is superior to competing NIPTs, 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;

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, many third-party payers currently have negative coverage determinations or otherwise do not reimburse for average-risk patient populations or for microdeletions screening and we expect reimbursement for microdeletions screening to be low in the near term; also, most state Medicaid programs currently either reimburse at low rates or do not reimburse for our tests;

third-party payers are increasingly requiring that prior authorization be obtained prior to conducting genetic testing as a condition to reimbursing for it, which may reduce or delay the reimbursement amounts we receive for Panorama or our other 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; furthermore, we may be unable to achieve stable reimbursement for microdeletions unless and until sufficient validation data on the sensitivity and specificity of our test for these conditions becomes available, which may take longer than we anticipate;

Table of Contents

our sales and marketing efforts, including through our laboratory partners and licensees, may fail to effectively reach customers or effectively communicate the benefits of Panorama;

our laboratory partners may choose to develop their own tests that are competitive with ours or 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;

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

we may experience increased cost of product, licensing and other revenues as a percentage of total revenues, as was the case for each of the years ended December 31, 2016 and 2015;

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;

competitors in the NIPT market may convince laboratories, clinics, clinicians, physicians, payers or patients that their offerings are superior from a performance, reliability or pricing perspective; and more effective and/or less expensive tests that deliver comparable results as our tests may be developed and commercialized;

we may fail to adequately protect our intellectual property relating to Panorama, leading to increased competition, or others may claim we infringe their intellectual property rights; if we are required to pay license fees in order to license third party intellectual property rights due to actual or alleged infringement based on our running Panorama, we may experience increased costs in running Panorama, and we may be unable to pass such costs on to our customers; and

we may not be successful in commercializing our cloud-based distribution model.

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 three months ended September 30, 2017 and 2016 was $27.1 million and $26.0 million, respectively. Our net loss for the years ended December 31, 2016, 2015 and 2014 was $95.8 million, $70.3 million and $5.2 million, respectively. As of September 30, 2017 and December 31, 2016, we had an accumulated deficit of $436.7 million and $345.9 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 DNA-based testing solutions, including in the field of cancer.

In addition, the rate of growth in our revenues has generally been negative, low or flat in recent quarters, and this trend may continue in future periods. In particular, 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 or for microdeletions screening. Therefore, going in-network with third-party payers has had, and may continue to have, an adverse impact on our revenues if we are unable to continue to increase adoption of, and obtain

Table of Contents

favorable coverage determinations for reimbursement for, our products. Furthermore, a new CPT code for microdeletions went into effect beginning January 1, 2017. We have experienced low average reimbursement rates thus far for microdeletions testing under this new code, and we expect that this new code will cause, at least in the near term, our microdeletions reimbursement to remain low, either due to reduced reimbursement, or third-party payers declining to reimburse, under the new code, which has had and will likely continue to have an adverse effect on our revenues.

Although we receive license fees for use of our bioinformatics technology under our Constellation cloud-based distribution model, because we do not perform the molecular biology analysis in our laboratory under this model, 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, 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 currently 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.

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 or services, including future cancer diagnostic 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; we intend to continue to increase our efforts to expand our platform and apply our expertise in processing and analyzing cell-free DNA to the field of cancer, and have just recently launched our first offering in the field of cancer, for research use only. 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 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 for cancer screening, 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 have occasionally implemented updates to Panorama to, among others, reduce the costs of running the test and increase efficiency, and most recently to add the ability to screen for certain conditions in twin pregnancies. We expect to continue to implement updates over time; however, we may experience unforeseen difficulties with the updated processes, which may result in increased costs and the diversion of management’s attention and resources from other business matters.

The launch of any new 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 experience delays during clinical development due to slower than anticipated enrollment, which we experienced in the past with our SMART study, or due to changes in study design or other unforeseen circumstances, such as our decision to expand our SMART study to

Table of Contents

include a larger number of patients; 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 enhanced or new 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 design, find and engage with sites for, enroll, afford, complete or achieve the desired results from any clinical studies that are necessary to support the development, regulatory requirements, or target commercial profile of any test;

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, or services that we may offer, can be provided at acceptable cost and with appropriate quality;

our competitors will not introduce tests or services that have superior performance, lower prices or other characteristics that cause physicians to recommend, or consumers to choose, such competing tests or services over ours; 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 or other difficulties 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.

We recently launched our Evercord cord blood and cord tissue banking service in April 2017; our Vistara single-gene mutations screening test in May 2017; our Signatera (RUO) recurrence monitoring liquid biopsy offering for research use only in August 2017; and our twin pregnancies screening capability for Panorama in October 2017. We cannot be certain that we will be successful in commercializing these or any new product offerings, as further described in the risk factor entitled “—If we are unable to successfully grow revenues for products or services in addition to Panorama, our business and results of operations may be adversely affected.”

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 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 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 currently 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, to the extent

Table of Contents

that we continue to spend considerably on 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. Fluctuations in quarterly results and key metrics may cause those results to fall below our financial guidance or other projections, or the expectations of analysts or investors, which could cause the price of our common stock to decline. We 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 respect to our current or future products or services, we may be unable to increase or sustain our revenues or achieve profitability.

We compete in the molecular testing field, which is characterized by rapid technological changes, frequent new product introductions, changing customer preferences, emerging competition, evolving industry standards, intellectual property disputes, price competition, reimbursement challenges, and aggressive marketing practices. Our principal competition in this field comes from existing testing methods, technologies and products, including other NIPTs and carrier screening tests offered by our competitors, that are used by 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 displace or supplement. In addition, new testing methods may be developed which may displace or be preferred over NIPTs, such as whole genome sequencing or single cell analysis. We are new to the cord blood and tissue banking field and face competition in that business from established companies with many years of experience in the industry. We are also new to the field of cancer diagnostics and face competition from other companies, many of which are larger, more established and have more experience and more resources than we do. Moreover, many companies in our markets are offering, or may offer, competing products and services at a lower cost than ours. We cannot assure you that research, discoveries or other advancements by other companies will not render our existing or potential products and services uneconomical or result in products and services that are superior or otherwise preferable to our current or future products and services.

We compete with numerous companies in the genetic diagnostics space. Our competitors in NIPT include Sequenom, which was recently acquired by LabCorp; Illumina, through its subsidiary Verinata; Ariosa, Inc., a subsidiary of F. Hoffman La-Roche Ltd, or Roche; Counsyl, Inc.; Quest; Premaitha Health PLC; Beijing Genomics Institute; Berry Genomics Co., Ltd.; Progenity; LifeCodexx AG; Synlab International GmbH; and Multiplicom N.V., which was recently acquired by Agilent Technologies Inc. In addition, a business unit of OPKO Health, Inc., Bio-Reference, which was previously a laboratory distribution partner of ours, is commercializing a competing NIPT. 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., which has been acquired by Invitae Corp.; Progenity; Quest; Recombine Inc.; NxGen MDx LLC; Fulgent Genetics; and GenPath Diagnostics, a business unit of Bio-Reference. In cord blood and tissue banking, we compete with companies such as Cord Blood Registry, a subsidiary of AMAG Pharmaceuticals, Inc.; ViaCord, a division of PerkinElmer, Inc.; Cryo-Cell International, Inc.; CorCell Companies, Inc.; LifeBankUSA; AlphaCord LLC; StemCyte USA; and CariCord. In the field of cancer, we face competition from various companies that offer or seek to offer competing solutions, such as Roche Molecular Systems Inc., a subsidiary of Roche, and Grail, which was spun off from Illumina. In addition, Guardant Health, Inc., Personal Genome Diagnostics, Inc., Foundation Medicine, Inc., in which Roche has a majority ownership stake, 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 same type of cancer diagnostic tests as Signatera and other cancer diagnostic tests that we are seeking to develop. Many other companies, including much larger companies than ours, have announced that they are developing and seeking to commercialize liquid biopsy tests. 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 and services are sold at a lower price than ours. 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 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

Table of Contents

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 utilize a cloud-based distribution model to deploy our bioinformatics technology for use by other laboratories. 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 our Panorama technology, 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 remains uncertain whether and to what extent our cloud-based distribution model will achieve and sustain high levels of customer demand and market acceptance.

Deploying this 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, one of our main competitors through its subsidiary Verinata, 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”

allegations or 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, 2017, we have agreements with only 23 licensees under our cloud-based distribution model, and we have only been recognizing revenue under our cloud-based distribution model for NIPT for seven full quarters. Only nine of our licensees are using Constellation commercially to market NIPT products, 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 implementation. The rate of adoption of our cloud-based distribution model continues to be slower than we anticipated, and depends 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. Because we do not control the manufacturing and specifications of the NGS equipment, some clinical laboratories may not be able to use Constellation. In particular, all of our licensees under our cloud-based distribution model are required to use Illumina sequencers and reagents to run their tests that they develop based on our technology. As further

Table of Contents

described in the risk factor 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”, we are aware that Illumina has required our licensees to pay an additional license fee in certain jurisdictions in order to secure a supply agreement for the sequencers and reagents necessary to run NIPT under our cloud-based distribution model. Furthermore, Illumina competes with us through Verinata, and may not charge a similar license fee for Verinata’s cloud-based software offering. As a result, our potential or current licensees may be unable to commercially launch their tests under our cloud-based distribution model in a financially viable manner, which has dissuaded and could continue to dissuade potential or current licensees from licensing from us or launching a test based on our technology.

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 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 in jurisdictions, including the United States, if we do not comply with ongoing regulatory requirements in such jurisdictions, including if we are required to obtain FDA clearance or approval to market our software for diagnostic purposes.

We utilize our Constellation software to aid in the calculation of test data. Our licensees have access to this software under our cloud-based distribution model. We have received a CE Mark from the European Commission for our Constellation software, through which our laboratory licensees access our algorithms, as well as for the key reagents that our laboratory licensees need in order to run their NIPT based on our technology. This enables us to offer Constellation for NIPT in the European Union and other countries that accept a CE Mark. However, as further described in the risk factor entitled “—Failure to obtain necessary regulatory approvals in foreign jurisdictions may adversely affect our ability to expand our operations internationally,” we have not obtained a CE Mark for our Panorama test as a whole. This has caused confusion among the regulatory authorities in some countries in the European Union, and we have had to, and may in the future be required to, address inquiries from regulatory authorities in such countries.

It is possible that we will need to obtain regulatory clearance or approval in the United States and elsewhere for our Constellation software in order for it to be used by third parties in the development and commercialization of their diagnostic tests based on our technology. We are currently engaged in discussions with the FDA regarding the regulatory status of a portion of our Constellation software, the copy number calculator, or CNC, to make calls of copy number variants, which are genetic mutations in which relatively large regions of the genome have been deleted or duplicated, which could be used to support our cloud-based distribution model for NIPT in the United States. The FDA has indicated to us that the CNC may be appropriate for review under the de novo classification process, which is less burdensome than the premarket approval, or PMA, 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. If necessary, we intend to seek regulatory clearance or approval for our Constellation software; however, we cannot guarantee that we will obtain such clearance or approval. If clearance or approval is required by the FDA 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 or approval in the United States, 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

Table of Contents

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 to the extent required, we may not be permitted to offer our Constellation software 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 a laboratory developed test, or 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, we would not receive the anticipated revenues from that licensee, and potential or other current licensees may be dissuaded from utilizing our Constellation software.

We may be subject to increased compliance risks as a result of our rapid growth, including our dependence on our sales, marketing and billing personnel.

Approximately 84% of our revenues for the three months ended September 30, 2017 were attributable to our U.S. direct sales. Prior to 2016, we experienced rapid growth in our U.S.-based internal sales force, and in our billing and marketing personnel, which required us to expand our training and compliance efforts in line with the increase in personnel in these functions. We continue to monitor our sales, billing, marketing and other personnel; however, we have in the past experienced, and may in the future experience, situations in which employees fail to strictly adhere to our policies. In addition, our billing and marketing messaging can be complex and nuanced, and there may be errors or misunderstandings in our employees’ communication of such messaging. Furthermore, as we scale up our sales and marketing efforts in line with the growth in our business, in particular our increased pace of product launches, we face an increased need to continuously monitor and improve our policies, processes and procedures to maintain compliance with a growing number and variety of laws and regulations, including with respect to consumer marketing. 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 and platforms 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 operated by Amazon Web Services, or AWS, located in the United States. Any technical problems that may arise in connection with our on-site data center or with the AWS 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. For example, earlier this year AWS experienced an outage at one of its main storage systems in the United States, which resulted in a large portion of the system being offline and inaccessible for several hours. While our software and platforms were not materially affected by this outage, future outages that are more severe or other issues with AWS’s facilities could materially impact our operations.

In addition, our proprietary bioinformatics algorithms are a crucial component of our test processing, and combine information derived from our mmPCR assay workflows with publicly available data from the broader scientific community to analyze and return test results. We host the significant majority of these algorithms on a cloud-based software platform pursuant to an agreement with DNAnexus, Inc., or DNAnexus, and both we and our Constellation licensees access our algorithms through the DNAnexus platform. The DNAnexus platform is also hosted on AWS servers. These algorithms cannot currently be run other than through the DNAnexus platform; they are currently used to run our Panorama NIPT, NIPT analysis for our Constellation licensees, our Signatera (RUO) liquid biopsy test, and for certain of our research and development activities, and we plan to utilize the platform for additional applications in the future. In the event of any failure in the DNAnexus platform or the AWS servers on which the DNAnexus platform is hosted, or difficulties in or termination of our relationship with DNAnexus, we and our Constellation licensees may lose or be unable to access our proprietary algorithms and therefore be unable to process tests or conduct any other activities that require access to such algorithms. We do not have any backup platform, server or other means to host our algorithms, and may be unable to find

Table of Contents

and implement an alternative platform that is satisfactory for our needs on commercially reasonable terms, in a timely manner, or at all. Interruptions in our operations or service may reduce our revenue, cause us to issue refunds, result in the loss of customers, cause laboratory licensees to terminate their contracts with us, adversely affect our ability to attract new laboratory licensees, or harm our reputation. We could also be exposed to potential lawsuits and liability claims.

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 our product portfolio expands. We believe that our customers are particularly sensitive to test limitations and errors, including inaccurate test results and the need on occasion to perform second blood draws, or redraws, on patients, for which Panorama experiences a higher advertised rate than other NIPTs. As a result, if our tests do not perform as expected or favorably in comparison to competitive tests, 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 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, a higher than anticipated number of tests which require redraws or fail to produce results, or longer than expected turnaround times, which we sometimes experience as a result of issues with laboratory equipment, components or materials or otherwise. In addition, we regularly evaluate and refine our testing process. These refinements may not improve our tests as we expect, and may result in unanticipated issues that may adversely affect our test performance as described above. Furthermore, any changes to our testing process may require us to use new or different suppliers or materials with whom or which we are unfamiliar, and which may not perform as we anticipate.

In addition, as further discussed in the risk factor entitled “If we are unable to successfully grow revenues for our current or future products or services in addition to Panorama, our business and results of operations may be adversely affected,” we have just launched our Evercord service, which is in an industry in which we previously had no experience; we have also recently launched our new Vistara test and our Signatera oncology offering for research use only. Any failure to meet consumer expectations could harm our reputation.

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 certified laboratories. For example, a significant portion of our Horizon carrier screening testing, and our new Vistara single-gene mutations testing, is performed by third-party laboratories. In addition, we contract with a third-party laboratory to perform the processing and storage of our Evercord customers’ cord blood and cord tissue samples. These third-party laboratories are subject to contractual obligations to perform these services 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 in the past had issues with delivering results to us within the time frames we expected 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 test results to customers may be delayed or interrupted, which could result in a loss of customers and harm to our reputation. We may not have sufficient alternative backup if one or more of the third-party laboratories that we contract with are unable to satisfy our demand for this testing with sufficient performance, quality and timeliness. In particular, we do not have a backup laboratory for our Vistara or Evercord offerings. 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 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 these tests. In addition,

Table of Contents

certain third-party payers, including some state Medicaid payers, that we are under contract with may take the position that sending out 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 current or future products or services in addition to Panorama, our business and results of operations may be adversely affected.

Our ability to successfully grow revenues for products or services in addition to Panorama, such as Horizon, Spectrum, Anora, Vistara, Evercord and Signatera, is uncertain and is subject to many of the risks we face with respect to Panorama. For example, the adoption and demand for such products or services may not grow as we expect; we may not be able to demonstrate that such products or services are equivalent to or superior to competing products or services; third-party payers may not reimburse for our tests, or may set the amounts of such reimbursements at prices that do not allow us to cover our expenses; we and our laboratory partners may not be able to maintain and grow effective sales and marketing capabilities; our laboratory distribution 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 or services, our business and results of operations may be adversely affected.

We have only recently commercially launched Evercord, a private cord blood and tissue banking service. Our success with this service offering will be subject to many of the risks affecting our business generally, as well as the inherent difficulty associated with launching a new offering, and in an industry that is new to us and that includes competitors who have been operating for many years. We may face unforeseen difficulties in a number of areas, including with Bloodworks Northwest, or Bloodworks, which is our partner providing the processing and storage services, and storage facility, for this offering; our other suppliers and service providers; our and Bloodworks’ ability to maintain required regulatory registrations from the FDA; or disruption of our business and distraction of our employees and management, as described in the risk factor entitled “If we are unable to successfully scale our operations, our business could suffer.” Similarly, we recently launched Vistara, our single-gene mutations panel, to OB/GYNs and Signatera, our recurrence monitoring liquid biopsy test for research use only, both of which are also subject to many of the risks affecting our business generally as well as the risks inherent in launching a new product and, in the case of Vistara, with a commercial partner. We have had to review and, in some cases, revise our processes, procedures and agreements with our business partners to address unforeseen operational issues and other contingencies, and will likely continue to do so as these areas of our business grow. We cannot assure you that our Evercord, Vistara or Signatera offerings will be successful.

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 reimbursement by third-party payers and for regulatory approvals or clearances, our business, financial condition, results of operations and reputation could be adversely affected.

As the healthcare reimbursement system and medical community 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. This is particularly true with respect to testing in the average-risk pregnancy population and for microdeletions screening using our Panorama test. For example, in January 2017 we published data from our DNAFirst study showing that NIPT can be effectively and appropriately offered as a primary screen for all pregnant women regardless of risk due to maternal age or other factors; however, this data is relatively new and is still being analyzed, and we cannot be certain whether or to what extent it will impact coverage or adoption of Panorama in the average-risk population.

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

Table of Contents

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. For example, we may experience delays during clinical development due to slower than anticipated enrollment, which we experienced in the past with our SMART study, or due to changes in study design or other unforeseen circumstances, such as our decision to expand our SMART study to include a larger number of patients. 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 or regulatory approvals in foreign jurisdictions. Limited results from earlier-stage verification studies may not predict results from studies in larger numbers of subjects drawn from more diverse populations over longer periods 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 Vistara single-gene mutations testing, and the processing and storage of cord blood and cord tissue for our Evercord offering. We have no backup or redundant facility to perform our main product and source of revenue, Panorama, which we perform at our San Carlos, California laboratory facility. This facility is situated near active earthquake fault lines. Our facility 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 and Signatera and for our development activities relating to 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 do not have alternatives other than to use Illumina sequencers and reagents to run the tests that they develop based on our technology. In addition, Illumina and Sequenom, which has been acquired by LabCorp, have entered into a patent pooling agreement pursuant to which both parties have pooled their intellectual property directed to NIPT. We understand from public filings that under the patent pooling agreement, Illumina has the exclusive worldwide rights to, among other things, license third-party laboratories to develop and sell NIPTs utilizing the pooled intellectual property and to enforce the pooled intellectual property against suspected infringers. Under our supply agreement with Illumina, we do not have an express license to the pooled intellectual property for running our own tests or to grant rights under the pooled intellectual property to the licensees under our cloud-based distribution model. We are aware that Illumina has required our licensees, in order to secure a supply agreement for the sequencers and reagents necessary to run NIPT under our cloud-based distribution model, to pay an additional fee for a license under the pooled intellectual property

Table of Contents

in jurisdictions in which Illumina believes certain of the pooled intellectual property is enforceable. This additional fee has dissuaded and could continue to dissuade potential or current licensees from licensing from us or launching a test based on our technology. In addition, while our supply agreement with Illumina does not allow Illumina to charge us an additional fee, Illumina could attempt to require us to pay such a fee by, for example, bringing a patent infringement lawsuit against us. While we believe that our commercialization of Panorama in the United States does not infringe any valid patents included in the pooled intellectual property, we cannot be certain as to the outcome of a lawsuit based on this intellectual property, and the costs and distraction to management of defending against such a lawsuit would likely be significant. In addition, Illumina directly competes with us in the NIPT market through its subsidiary, Verinata. We understand Illumina supplies the same or similar sequencers and consumables to Verinata. Because of Illumina's ownership of Verinata, we face increased risk and uncertainty regarding continuity of a successful working relationship with Illumina under our supply agreement, as well as in our ability to compete with Verinata in the marketplace in view of economic advantages enjoyed by Verinata with respect to 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, reagents or other components, these efforts may require significant resources, expenditures and time and attention of management, and we may not be successful in selecting, acquiring on commercially reasonable terms, and implementing alternative platforms, reagents or other components that are 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 under a supply arrangement with Streck under which we are required to exclusively use Streck tubes. All of the licensees under our cloud-based distribution model also have no current alternative but 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, nonetheless, 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 also exclusively use such sole-sourced components to run the tests they develop based on our technology, and our laboratory distribution partners must 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 our quality control requirements, particularly in the case of sole suppliers such as Streck and Illumina, could impact our test performance or affect our ability to perform our tests in a timely manner or at all, and 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 activities, including efforts to market and commercialize Panorama. In the event of any adverse developments with our sole suppliers, or if any of our sole suppliers modifies any of the components they supply to us, our ability to supply our products may be interrupted, and obtaining substitute components could be difficult or require us to re-design or re-validate our products or, for any products for which we may obtain such approval, obtain approval from the FDA to use a new supplier. For example, Streck has informed us that it plans to modify the blood collection tubes that it supplies to us, and as a result, we are in the process of re-validating the modified blood collection tube for use with our Panorama test. In addition, if we obtain a premarket approval, or PMA, for Panorama as an in vitro diagnostic, or IVD, such issues with suppliers or the components that we source from suppliers could affect our commercialization efforts for such an IVD, 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, 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

Table of Contents

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 our quality control requirements. In many cases, our suppliers are not contractually required to supply these components to the quality or performance standards that we require. If the supply of components we receive do not meet our quality control or performance standards, we may not be able to use the components, or if we use them not knowing that they are of inadequate quality, which occasionally occurs 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.

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

Our core 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. Likewise, we rely on courier services to transport cord blood and tissue samples to Bloodworks’ facility in which the samples will be processed and stored. 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 or store 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 personal information, such as test results and other patient health information, 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.

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, European data privacy regulations, such as the General Data Protection Regulation, or GDPR, 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

Table of Contents

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 contractually prohibit our licensees from sending personally-identifiable information to our cloud servers, and the vendor that hosts our software in the cloud is contractually required to comply with data privacy laws, such as HIPAA. However, we cannot be certain that these third parties will comply with the terms of our agreements, nor that they will not experience security breaches or other disruptions.

Our cord blood and tissue banking activities are subject to regulations that may impose significant costs and restrictions on us.

Our Evercord cord blood and tissue banking service is subject to FDA regulatory oversight. Pursuant to FDA regulations, an individual or entity that performs any of the manufacturing steps in banking stem cells from peripheral and cord blood (recovery, processing, donor screening, donor testing, storage, labeling, packaging, or distribution) must register with the FDA unless an exception applies. Based on our direct activities, we are subject to FDA requirements and we may be subject to FDA inspection. We have registered with the FDA as an establishment engaged in specific manufacturing steps, including collecting cord blood and tissue samples, donor screening and distribution of cord blood HCPs. We have contracted with Bloodworks, another FDA-registered establishment, to perform other manufacturing steps in the process on our behalf, which we may do as a registered establishment. As the contractor establishment, we remain responsible for ensuring that our subcontractors perform each manufacturing step in compliance with applicable requirements, and are required to terminate any arrangement if our subcontractor is non-compliant. While we are not required to validate and oversee the processes of our subcontractor registered establishments, we are required to make an initial determination that the subcontractor is compliant, and to have policies and procedures in place to ensure that the subcontractor remains compliant throughout the term of the arrangement. We have made this determination with respect to Bloodworks and have put such procedures in place. We are also responsible for any manufacturing step performed on our behalf by an individual or entity that is not required to register with the FDA, such as the doctors and midwives who perform the collection of the cord blood and tissue.

We are also required to comply with good tissue practice regulations, or GTPs, that establish a comprehensive regulatory program for human cellular and tissue-based products. We believe that we currently comply with GTP standards. However, the FDA may determine that we are not compliant or, even if we are currently compliant, we may not be able to maintain this compliance or comply with future regulatory requirements that may be imposed on us.

In certain states, manufacturing steps in banking stem cells from cord blood and tissue are subject to state licensure or registration and compliance with state requirements. Based on our review of applicable state laws by outside counsel, we, and our subcontractors engaged in specific manufacturing steps, may be required to obtain licensure or register in the states that regulate private cord blood and/or tissue banking activities, which include California, Delaware, Illinois Maryland, New Jersey, New York, Oregon and Washington.

If the facility at which our customers’ cord blood samples are processed and stored is damaged or destroyed, our cord blood business and prospects could be negatively affected.

The cord blood and tissue samples that we collect are processed and stored by Bloodworks at its facility in Seattle, Washington. Bloodworks’ facility is situated near active earthquake fault lines. If this facility or the equipment in the facility are significantly damaged or destroyed by natural or manmade disasters, including earthquakes, flooding or power outages, we could suffer a loss of some or all of the stored cord blood and tissue units. If we encounter problems during transportation, including while our customers’ samples are in the possession of third-party commercial carriers that we

Table of Contents

contract with to transport the samples, some or all of the transported units could be damaged. Depending on the extent of these losses, such an event could impact our ability to process and store the cord blood and tissue samples, expose us to significant liability from our customers and affect our ability to continue to provide cord blood preservation services.

Damage to or loss of our Evercord customers’ cord blood and cord tissue samples held in our custody could potentially result in significant legal liability and harm our reputation.

Our reputation among clients and the medical and birthing services community is extremely important to the commercial success of our Evercord service offering. This is due in significant part to the nature of the service we provide – as we are assuming custodial care of a child’s umbilical cord blood stem cells entrusted to us by the parents for potential future use as a therapeutic for the child or a close relative. We believe that our reputation, and Bloodworks’ reputation, enables us to market Evercord as a competitive cord blood and tissue preservation service in a crowded marketplace. However, we may experience unforeseen issues, such as loss of or damage to a sample during transit, during the preservation process or while in storage. Any such problems, particularly if publicized, could negatively impact our reputation, which could adversely affect our business and business prospects. If our Evercord offering does not meet customer or other public expectations, any resulting harm to our reputation could extend beyond Evercord to our core women’s health and genetic testing business, which comprises the substantial portion of our revenue, because Evercord is promoted to the same OB/GYNs who prescribe and order many of our other products.

In addition to reputational damage, we face the risk of legal liability for loss of or damage to cord blood units. We do not own the cord blood units banked by our cord blood banking customers; instead, we act as custodian on behalf of the child-donor’s parent or guardian. Loss of or damage to the units would be loss of or damage to the customer’s property. We have included provisions in our enrollment agreement for this service, limiting our liability. However, we cannot be sure to what extent we could nevertheless be found liable for damages suffered as a result of harm to or loss of a cord blood unit, and if we are found liable, whether our insurance coverage will be sufficient to cover such damages.

We offer a quality service guarantee, which provides that, subject to certain conditions, if an Evercord customer’s cord blood and tissue sample is used for a transplant and fails to engraft, or begin to grow and develop, we will refund all service fees paid to us by the customer plus an additional $100,000. Failure to engraft can occur for a variety of reasons, and may occur more frequently than we anticipate. Frequent failures to engraft could result in many customers making claims under our quality service guarantee, which could adversely impact the profitability of this service offering.

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 or as claimed in our promotional materials, 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 for failure to provide such information, in connection with our marketing and promotional activities or 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 for which we delivered a low-risk result because the Panorama result was a so-called false negative. Even though Panorama is highly accurate, it is not 100% accurate and we may report false negative results. If the resulting baby with the condition is born, 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 carrier screening test that was ordered. See 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

Table of Contents

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 and product offerings grow, we will need to continue to ramp up our testing capacity and implement increases in scale. We will need additional or new equipment, laboratory space and qualified laboratory personnel, and will need to increase office space, expand our customer service capabilities, implement billing and systems process improvements, enhance our controls and procedures and expand our internal quality assurance program and technology platform. 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. For example, earlier this year we experienced a delay in our claims submissions and processing as a result of transitioning most of our insurance billing operations from our headquarters to our facility in Austin, Texas, which resulted in our delayed receipt of approximately $1.5 million of insurance payments and impacted our revenue for that quarter. In addition, our efforts to scale our operations may be unable to keep pace with an increase in the frequency of our launches of new or enhanced products and services, such as the three new products we have already launched to date this year and future additional offerings and product enhancements. As we continue to launch additional offerings and product enhancements, we will need to manage our resources among various initiatives, and such competing priorities could lead to delays in one or more of our business initiatives. Conversely, to the extent that we scale our operations, infrastructure and other resources but do not ultimately meet our anticipated timelines in our product development efforts, we will experience higher costs and expenses than necessary until our project timelines and operational resources become aligned. We may also, intentionally or unintentionally, allocate resources to new products or initiatives in a manner disproportionate to the amount of revenue that such initiatives generate compared to our existing or core offerings. 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 business 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, research and development and other technical personnel and especially in the San Francisco Bay Area where our headquarters and laboratory facility is located, and the turnover rate of such personnel 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 highly qualified 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. 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. To the extent that our current or potential employees perceive the value of our equity awards to be low, our ability to recruit, retain and motivate highly skilled employees may be adversely affected, which could then have an adverse effect on our business and future growth prospects. Furthermore, to the extent that we are unable to retain our employees and they leave our company to join one of our competitors, we cannot assure you that any invention, non-disclosure or non-compete agreements we have in place will provide meaningful protection against a departing employee’s unauthorized use or disclosure of our confidential information, as further discussed in “—Risks Relating to our Intellectual Property— 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.”

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.

Table of Contents

If our laboratory partners do not effectively market or sell, or decide to stop selling, our products, or our relationships with our laboratory partners are otherwise terminated, 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 increased the focus of our commercial efforts on our U.S. direct sales force, we continue to rely on relationships with 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, develop and commercialize or otherwise sell competing 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 has happened in the past. Laboratory partners that are not bound by obligations of exclusivity or non-competition to us or our products could decide to develop their own product that competes with ours or sell a competing product and may choose to promote such tests in addition to or in lieu of our tests. For example, we terminated our licensing and distribution agreement with Bio-Reference in January 2017, and Bio-Reference began selling a competing NIPT. 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.

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.

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 due to operating, offering our products, or contracting with employees, contractors and other service providers in these other countries. 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.

Table of Contents

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 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 or licensees 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; experience difficulties in staffing and managing foreign operations, including under labor and employment laws and regulations that are new or unfamiliar to us; 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 experience reduced or varied protection for intellectual property rights and practical difficulties in enforcing intellectual property and other rights, including with respect to assignment of inventions to us by our consultants in foreign jurisdictions.

Outside the United States we enlist local and regional laboratories, contract employees 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 is 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 and other activities utilized by our distribution partners, contract employees and other service providers that are locally acceptable may not comply with relevant standards required under United States laws that apply to our operations overseas, including through third parties, 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, contractors or agents abroad. Non-compliance by us or our employees, contractors 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. Furthermore, the legal landscape governing advertising, promotional and other marketing activities can vary widely from jurisdiction to jurisdiction, and is often more complex, less clear or less developed than in the United States. If our marketing activities are found to be in violation of local laws, regulations or practices, we may be subject to fines and other penalties, and may be required to cease marketing or commercialization activities in such jurisdiction. 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.

Table of Contents

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 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 on 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, and may impose other constraints on us and our operations, as is the case under our 2017 Term Loan, as further described in the risk factor entitled “—Our outstanding debt may impair our financial and operating flexibility.” 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.

Table of Contents

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, 2017 and December 31, 2016, we had approximately $125.1 million and $49.6 million, respectively, of debt outstanding with accrued interest. On August 8, 2017, we completed our 2017 Term Loan under which we borrowed $75.0 million. In addition, we have $50.1 million outstanding under our Credit Line with UBS. Except for operating leases, we do not have any off-balance sheet financing arrangements in place or available. Our debt agreements contain various restrictive covenants and are secured by 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. If we default under our outstanding debt under the 2017 Line of Credit or the Credit Line and if the default is not cured or waived, the lenders could terminate their commitments to lend to us and cause any amounts outstanding to be payable immediately. Under certain circumstances, they could also exercise their rights under the security agreements entered into in connection with the loans. Such a default could also result in cross defaults under other debt instruments. Moreover, any such default would limit our ability to obtain additional financing, which may have an adverse effect on our cash flow and liquidity.

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 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

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, including 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, 2016, we had federal and state NOL carryforwards of approximately $205.3 million and $109.6 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 $8.5 million, which begin to expire in 2027, and state research and development credit carryforwards of approximately $5.8 million, which can be carried forward indefinitely. Our ability to use these carryforwards could be limited if we experience "ownership changes."

Table of Contents

Our estimates of market opportunity and forecasts of market growth may prove to be inaccurate, and even if the market in which we compete achieves the forecasted growth, our business could fail to grow at similar rates.

Market opportunity estimates and growth forecasts are subject to significant uncertainty and are based on assumptions and estimates that may not prove to be accurate. Our publicly announced estimates and forecasts relating to the size and expected growth of our market may prove to be inaccurate. Even if the market in which we compete meets our size estimates and forecasted growth, our business could fail to grow at similar rates.

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, CMS, and state reimbursement programs for Panorama, will be necessary for us 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 will 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.

In making coverage determinations, third-party payers often rely on practice guidelines issued by professional societies. The American College of Medical Genetics and Genomics, or ACMG, has 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 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. ISPD has issued guidelines that are supportive of performing NIPT in average-risk pregnancies, as well as high-risk pregnancies. However, the American Congress 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, a number of 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. Many 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, we have and may continue to experience 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, including from our SMART study, which we have decided to expand in scope and therefore will not be completed within our initially anticipated timeline, we may be unable to obtain positive coverage determinations for our test. We do not expect to receive reimbursement for approximately 28,000 Panorama tests for average-risk patients and approximately 41,000 Panorama tests for microdeletions that we performed in the quarter ended September 30, 2017. 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, including to the extent that we continue to perform large volumes of tests for which we do not receive reimbursement.

Table of Contents

Furthermore, a new CPT code for microdeletions went into effect beginning January 1, 2017. We have experienced low average reimbursement rates thus far for microdeletions under this new code, and we expect that this new code will cause, at least in the near term, our microdeletions reimbursement to remain low, either due to third-party payers declining to reimburse or through reduced reimbursement, under the new code, which has had, and we expect to continue to have, an adverse effect on our revenues.

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, are considered experimental by third-party payers and, as a result, some payers have decided not to reimburse for such tests. In addition, some third-party payers 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, thereby limiting our reimbursement. Payers may also dispute our billing or coding. Based on any of the foregoing, third-party payers may also decide to deny payment or recoup payment for testing that they contend to have been not medically necessary, against their coverage determinations, or for which they have otherwise overpaid, and we may be required to refund reimbursements already received. We deal with requests for recoupment from third-party payers from time to time in the ordinary course of our business, and it is likely that we will continue to do so in the future. See “Commitments and Contingencies—Third-Party Payer Reimbursement Audits” in Note 6 to our Consolidated Financial Statements. If a third-party payer denies payment for testing, reimbursement revenue for our testing could decline. If a third-party payer successfully proves that payment for testing was in breach of contract or otherwise contrary to law, they may recoup payment, which amounts 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.

Furthermore, some of our contracts with third-party payers contain so-called most favored nation 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 nation 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. 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. While we have addressed these inquiries as and when they have arisen, there is no guarantee that we will always be successful in addressing such concerns in the future, which may result in a third-party payer deciding to reimburse for our tests at a lower rate or not at all, seeking recoupment of amounts previously paid to us, or bringing legal action seeking reimbursement of previous amounts paid. Any of such occurrences 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

Table of Contents

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 or if we are unable to successfully obtain reimbursement from state Medicaid programs.

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, which is relevant to NIPT. 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.

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 October 5, 2017, we are recognized by 46 states as a Medicaid provider. We may not be able to be recognized as a provider by additional 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 state Medicaid provider, and as a result our testing is not reimbursed by Medicaid programs in many of the states in which we are recognized as a Medicaid provider. 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, a 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 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 receive reimbursement have not entered into agreements with us that govern approval or payment terms. Therefore, such third-party payers could withdraw 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, or don’t have a policy in place to reimburse for microdeletions screening. In addition, the terms of

Table of Contents

certain of our agreements require a physician or qualified practitioner’s signature on test requisitions or put in place other controls and procedures prior to conducting a test, and third-party payers are increasingly requiring prior authorization to be obtained prior to conducting a test, as a condition to reimbursing for the 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 and may occur more frequently in the future, and 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 measures, 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, including with respect to prior authorization requirements and procedures; and

incorrect or missing billing information, which is required to be provided by the ordering 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 AMA generally assigns specific billing codes for laboratory tests under a coding system known as Current Procedure Terminology, or CPT, which we and our referring health care providers 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 set for diagnosis, commonly known as ICD-10, in October 2015. The AMA issued a CPT code for microdeletions in March 2016, and CMS provided a pricing benchmark for aneuploidy and microdeletions testing effective January 2017. However, our microdeletions reimbursement has decreased under this new code because third-party payers are declining to reimburse under this new code or reimbursing at a much lower rate than we had previously received. 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. 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. In addition, third-party payers may not establish positive coverage policies for our tests or adequately reimburse for any CPT code we may use, or seek recoupment for testing previously performed, which have occurred in the past.

Table of Contents

If the FDA were to begin actively regulating our tests, 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, such as our planned Signatera CLIA laboratory test, 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.

The regulation by the FDA of LDTs remains uncertain. In October 2014, the FDA issued draft guidances outlining its plan to actively regulate LDTs using a risk-based approach. In November 2016, the FDA announced that it no longer plans to finalize the 2014 draft guidances. In January 2017, the FDA issued a discussion paper that laid out elements of a possible revised future LDT regulatory framework, but did not establish any regulatory requirements. The FDA’s efforts to regulate LDTs prompted the drafting of legislation governing diagnostic products and services that sought to substantially revamp the regulation of both LDTs and IVDs. Congress may still act to provide further direction to the FDA on the regulation of LDTs.

In the meantime, the FDA could require us to seek premarket clearance or approval to offer our tests for clinical use even before it finalizes any future guidance. If FDA premarket clearance or approval is required, or if we voluntarily pursue FDA clearance 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 premarket clearance or approval 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 510(k), 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. For example, Illumina is our main sequencer and sequencing reagent supplier, Illumina. If we seek to achieve regulatory clearance or approval for Panorama, to the extent that Panorama incorporates Illumina’s sequencer or sequencing reagents, we may require Illumina’s cooperation in demonstrating safety and efficacy with respect to such components of our test. We may face difficulty obtaining cooperation from Illumina because Illumina is the parent company of Verinata, 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 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.

Table of Contents

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, including with respect to the product claims in our promotional materials, 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 by providing our testing services directly or through our laboratory partners, or through our licensees under our cloud-based distribution model. 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 by our licensees 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. For example, while we have obtained a CE Mark from the European Commission for our Constellation software and the key reagents required for our licensees to run their NIPT based on our technology, we have not obtained a CE Mark for our Panorama test as a whole. Therefore, while we are able to offer Constellation in the European Union and other countries that accept a CE Mark, we are unable to offer Panorama directly in these jurisdictions, which may put us at a competitive disadvantage to our competitors in these jurisdictions, some of whom have obtained a CE Mark for their end to end NIPT. In addition, the European Commission has published new directives regulating, among others, IVDs, which are expected to become effective in 2022. The new regulations will require companies providing genetic testing services to obtain a CE Mark for what will be considered IVDs, or a CE-IVD; in addition to requiring notified body approval for various classes of devices, including prenatal tests such as Panorama, companies will also be required to submit clinical evidence and post-market performance data to regulators after their tests have been approved and are commercialized. Furthermore, to the extent that regulatory authorities believe that we, our laboratory partners or our licensees may be marketing, commercializing or otherwise offering our tests without required approvals, they may raise questions or concerns which, if not addressed to their satisfaction, may result in our being required to cease offering our products, either directly or through our partners or licensees, in the relevant country. This may in turn result in similar concerns, and subsequent cessation of our sources of revenue, in other countries. We are currently addressing inquiries from a regulatory authority of one country in the European Union. While we believe that we are in compliance with the regulatory requirements of this jurisdiction, such regulatory authority may disagree. We have in the past addressed similar inquiries from regulatory authorities in the European Union, and may in the future face questions from regulatory authorities in various countries with respect to Panorama or Constellation.

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.

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, accreditation, registration 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

Table of Contents

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 current or future 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 such as those described in this risk factor, 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.

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 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.

Table of Contents

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 government 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 government 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 restricts insurers from charging higher premiums or denying coverage to individuals with pre-existing conditions, and requires insurers to cover certain preventative services without charging any copayment or coinsurance, including screening for lung, breast, colorectal and cervical cancers. 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. Furthermore, there have 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 current United States President and Congress have attempted to make changes to or eliminate the entirety of the PPACA. These attempts have resulted in considerable uncertainty and concern regarding, for example, electing to undergo genetic screening and whether doing so may impact health insurance eligibility. Because it is unclear whether or not, or how, the PPACA may change, and whether and to what extent NIPT, cancer screening or other genetic screening 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, introduced a multi-year pricing program for services payable under the CLFS that is designed to bring Medicare allowable amounts in line with the amounts paid by private payers. The rule issued by CMS to implement PAMA required certain laboratories to report third-party payer rates and test volumes. Beginning January 1, 2018, the Medicare payment rate for these tests will be equal to the weighted median private payer rate reported to CMS. CMS has published preliminary payment rates based on the reported data. The preliminary rates for many tests are lower than the previous CLFS payment rates, due to the often lower negotiated private payer rates applicable to large commercial laboratories that were required to report data to CMS. While we believe that the preliminary rates will have minimal impact on our business, the rates have been the subject of controversy in the industry, and it is unclear whether and to what extent the new rates will affect overall pricing and reimbursement for clinical laboratory testing services. 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

Table of Contents

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. Current or potential future 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 distribution 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 significant 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;

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, and state data privacy and security laws.

Table of Contents

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 of up to approximately $22,000 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. As described further in Item 1—Legal Proceedings, we have received a civil investigative demand from the United States Department of Justice in connection with what we understand to be a qui tam action and have produced documents in response. An adverse ruling in this proceeding could require us to pay treble damages, civil penalties, and attorneys’ fees, costs and expenses, which could materially and adversely affect our business, financial condition and results of operations.

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.

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 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;

the protection of computing systems and personal devices (such as cell phones and tablets) that maintain protected health information; and

analysis of security incidents and breach notification requirements.

Table of Contents

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 laws and 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, the interpretation and application of health-related, privacy and data protection laws in the European Union and elsewhere are often uncertain, contradictory and in flux; for example, the European Union has adopted new data privacy regulations, the GDPR, which became effective in 2016 and will become enforceable May 2018. These regulations comprehensively reform the prior data protection rules of the European Union in order to protect the use and disclosure of personal information, and are more stringent and apply to a broader range of personal data than those in the United States. The GDPR is applicable to U.S.-based companies, such as ours, that do business or offer services in the European Union. Our current processes and practices do not comply with the GDPR, and we will need to expend considerable time and resources, including management attention, to revise our practices and bring them into compliance.

As we continue to expand and grow our business, our overall compliance with applicable laws and regulations may result in increased costs and attention of management, and failure to comply may result in significant fines, penalties and damage to our reputation. Additionally, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. If so, we could be subject to 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.

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. In addition, we have recently launched Signatera as an RUO offering. 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 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, such as us with respect to Signatera, including requiring the supplier to seek clearance or approval for the products. We may be required to cease offering Signatera, or our RUO suppliers may cease selling their respective 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.

Table of Contents

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. We are using these sequencers, reagents and blood collection tubes for clinical diagnostic use. 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.

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.

Risks Related to Our Intellectual Property

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 or services.

Our success depends in part on our non-infringement of the patents or intellectual property rights of third parties. Third parties, including our competitors, have asserted and may in the future assert that we are employing their proprietary technology without authorization or that we are otherwise infringing their intellectual property rights. For example, we are presently aware of at least one instance in which a competitor has asserted to us and to third parties that it has an issued patent that covers one or more of our tests in the United States; while this competitor has not filed any patent infringement action based on this assertion, such an action could be brought at any time. 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 required to stop developing or commercializing products or services; pay potentially

Table of Contents

substantial monetary damages; and/or 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. In addition, we could encounter delays in product introductions while we attempt to develop alternative non-infringing products. Any of these or other adverse outcomes could prevent us from offering our tests, which would have a material adverse effect on our business, financial condition and our results of operations.

We operate in a crowded technology area in which there has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the genetic diagnostics industry. 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. The number of contested intellectual property proceedings 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, competitors in such markets may assert their patents and other proprietary rights against us as a means of blocking or 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 patent owners or licensees who have no relevant product revenues and against whom our own patents may provide little or no deterrence or protection.

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.

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

Our success and ability to compete depend to a large extent on our ability to develop proprietary products and technologies and to maintain adequate protection of our intellectual property in the United States and other countries. 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. In addition, the proprietary positions of companies developing and commercializing tools for molecular diagnostics, including ours, generally are uncertain and involve complex legal and factual questions. This uncertainty may materially affect our ability to defend or obtain patents or to address the patents and patent applications owned or controlled by our collaborators and licensors.

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. 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 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.

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 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

Table of Contents

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 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.

There is also the risk that others may independently develop similar or alternative technologies or design around our patented technologies, and 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

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.

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, or as a result of our employees failing to abide by their confidentiality obligations during or upon termination of their employment with us. 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

Table of Contents

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 our employees’ 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.

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, as well as how those results compare to analyst and investor expectations;

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;

failure of analysts to initiate or maintain coverage of our company, issuance of new securities analysts' reports or changed recommendations for our stock;

forward-looking statements related to our financial guidance or projections, our failure to meet or exceed our financial guidance or projections or changes in our financial guidance or projections;

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.

Table of Contents

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 Item 1—Legal Proceedings, purported securities class action lawsuits have been filed against us, 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 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.

As a public company, we will continue to incur significantly increased costs and devote substantial management time.

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 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

Table of Contents

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 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.

Although we have determined that our internal control over financial reporting was effective as of December 31, 2016, we must continue to monitor and assess our internal controls over financial reporting. 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. 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.

Table of Contents

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. Currently, only a small number of securities analysts cover our stock. If more analysts do not commence coverage of us, or if industry analysts cease coverage of us or fail to publish reports on us regularly, 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 stock price would likely decline.

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

As of September 30, 2017, our directors and executive officers and their affiliates beneficially own, in the aggregate, approximately 44.2% 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;

Table of Contents

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 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.

Table of Contents

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.

None.

ITEM 3 DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5 OTHER INFORMATION

None.

ITEM 6 EXHIBITS

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*	Credit Agreement, dated as of August 8, 2017, by and between Natera, Inc. and Orbimed Royalty Opportunities II, LP.					X

Table of Contents


		Incorporated by Reference
Exhibit No.	Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
10.2*	Pledge & Security Agreement, dated as of August 8, 2017, by and between Natera, Inc., Natera International, Inc., NSTX, Inc. and Orbimed Royalty Opportunities II, LP.					X
10.3	Guarantee, dated as of August 8, 2017, by and between Natera International, Inc., NSTX, Inc. and Orbimed Royalty Opportunities II, 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
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.					X

Table of Contents

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

†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.

Table of Contents

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 8, 2017	By:	/ s / Matthew Rabinowitz
	Name:	Matthew Rabinowitz
	Title:	Chief Executive Officer, President, and Chairman
		(Principal Executive Officer)

	By:	/ s / Michael Brophy
	Name:	Michael Brophy
	Title:	Chief Financial Officer
		(Principal Financial and Accounting Officer)