UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the Quarterly Period Ended September 30, 2014

OR

Commission File Number 0-26483

 

diaDexus, Inc.

(Exact name of Registrant as Specified in its Charter)

 

 

(650) 246-6400

(Registrant’s telephone number, including area code)

 

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

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

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

 

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

The number of shares outstanding of the registrant’s common stock, $0.01 par value per share, was 55,315,806 as of October 31, 2014.

 

 

 

 

 

 

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DIADEXUS, INC.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2014

TABLE OF CONTENTS

 

 

 

 

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PART I – FINANCIAL INFORMATION

 

DIADEXUS, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share data)

 

See accompanying notes to condensed financial statements.

 

 

 

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DIADEXUS, INC.

CONDENSED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands, except share and per share data)

 

See accompanying notes to condensed financial statements.

 

 

 

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DIADEXUS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

 

See accompanying notes to condensed financial statements.

 

 

 

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diaDexus, Inc.

Notes to Condensed Financial Statements

 

1. Business Overview

Formation of the Company

diaDexus, Inc., a Delaware corporation (the “Company”), is a life sciences company focused on developing and commercializing proprietary diagnostic products addressing unmet needs in cardiovascular disease (“CVD”). The Company sells its diagnostic products to laboratories. Physicians order testing for their patients from these laboratories and use the results to aid in assessing their patients risk for CVD.

The Company’s products, PLAC^® Tests, are designed to provide information, over and above traditional risk factors, to help identify individuals at increased risk of suffering a heart attack or stroke. Some of these events may be reduced with earlier risk detection and more aggressive risk-reducing strategies, including treatment to lower LDL-cholesterol goals with statins. The Company has commercialized two PLAC Tests. One test, the PLAC Test ELISA Kit (the “PLAC ELISA Test”), measures the mass of circulating Lp-PLA₂ in the blood. The PLAC ELISA Test is the only Lp-PLA₂ blood test cleared by the US Food and Drug Administration (the “FDA”) to aid in assessing risk for both coronary heart disease and ischemic stroke associated with atherosclerosis. The second test, the PLAC Test for Lp-PLA₂ Activity (the “PLAC Activity Test”), is an enzyme assay for the quantitative determination of Lp-PLA₂ activity levels in human plasma and serum on automated clinical chemistry analyzers, to be used in conjunction with clinical evaluation and patient risk assessment as an indicator of atherosclerotic cardiovascular disease. The Company is currently commercializing the PLAC ELISA Test primarily in the United States and Europe and the PLAC Activity Test primarily in Europe.

The Company has incurred substantial losses since its inception, and expects to continue to incur net losses for at least the next few years. To date, the Company has funded its operations primarily through private placements of preferred stock and debt financing, as well as through revenue generated from the sale of products and service.

The Company expects to require additional financing and will seek to raise funds through equity or debt offerings, bank facilities, or other sources of capital. Additional funding may not be available when needed or on terms acceptable to the Company. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. The Company cannot assure you that it will be able to raise any such additional funding or that such funding would be on favorable terms.

In August 2014, the Company entered into a Loan and Security Agreement with Oxford Finance LLC (see Note 8 of these Notes to Condensed Financial Statements). The Loan and Security Agreement contains various covenants. If the Company breaches any of these covenants or is unable to make a required payment of principal or interest, or experiences a material adverse change to its business, it could result in an event of default under the Loan and Security Agreement. Upon the occurrence of an event of default under the Loan and Security Agreement, the lender could elect to declare all amounts outstanding to be immediately due and payable. If the Company is unable to repay the amounts due under the Loan and Security Agreement, the lender could proceed against the collateral granted to it to secure such indebtedness. The Company has pledged substantially all of its assets, other than its intellectual property, as collateral under the Loan and Security Agreement.

The Company’s future liquidity requirements may increase beyond currently expected levels if it fails to maintain compliance with the loan covenants. In order to meet the future liquidity needs, the Company may become reliant on additional equity and/or debt financing. Additional funding may not be available when needed or on terms acceptable to the Company. The consent of Oxford Finance LLC will likely be required for additional debt financings. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. The Company cannot assure you that it will be able to raise any such additional funding or, if available, that such funding would be on favorable terms.

PLAC Test ELISA Kit

The Company introduced its initial PLAC ELISA Test in 2004 which uses immunoassay microtiter plate technologies to measure levels of Lp-PLA₂. The infrastructure for performing microtiter plate tests typically exists only at large and midsize clinical reference laboratories and large hospitals, which must be certified by the US Department of Health and Human Services (“DHHS”) for high-complexity diagnostics under the Clinical Laboratory Improvement Amendments (“CLIA”). Smaller hospitals and clinics can order the PLAC ELISA Test for their patients from those institutions that are able to perform this test and offer the PLAC ELISA Test. Patients can have their blood drawn at a local laboratory and shipped to the more advanced institutions for analysis. The Company markets the PLAC ELISA Test in the United States, Europe, Israel and Mexico.

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PLAC Test for Lp-PLA₂ Activity

The Company introduced the PLAC Activity Test in Europe in March 2012. The PLAC Activity Test is an enzyme assay for the quantitative determination of Lp-PLA₂ activity levels in human serum or plasma. The PLAC Activity Test uses automated clinical chemistry technology which is more prevalent than the microtiter plate technology used for the PLAC ELISA Test. As such, a broader array of institutions can conduct the PLAC Activity Test. This group includes clinical laboratories and hospitals of all sizes and physician operated laboratories (“POLs”). In addition, the sample handling requirements are much less stringent for the PLAC Activity Test compared to the PLAC ELISA Test, allowing greater ease of use for those facilities processing specimens. The PLAC Activity Test is currently available in Europe for use in conjunction with clinical evaluation and patient risk assessment as an indicator of atherosclerotic cardiovascular disease. The Company affixed the CE marking for this intended use by self-certification in January 2012. The PLAC Activity Test is available on a commercial basis only in Europe. The Company is pursuing 510(k) clearance for this test from the FDA to commercialize this assay format in the United States.

The Company had a pre-submission meeting with the FDA in September 2013, which resulted in the Company advancing its clinical program to support the submission of the PLAC Activity Test to the FDA. The Company then partnered with a large longitudinal cardiovascular disease study, Reasons for Geographic and Racial Differences in Stroke (“REGARDS”), to validate the PLAC Activity Test. The Company completed the clinical study sample validation in the first quarter of 2014 and submitted a 510(k) application to the FDA in June 2014, which was accepted for substantive review in July 2014.

Pipeline

There are several published clinical studies that provide preliminary evidence that Lp-PLA₂ levels may have clinical utility in diseases or indications other than those for which the Company’s PLAC Tests are currently cleared. The Company intends to explore these other indications, while focusing on cardiovascular disease risks, such as risks of secondary cardiac events and risks of cardiac events in the context of other diseases.

In March 2014, the Company entered into an agreement to license the rights to develop and commercialize three independent biomarkers to aid in risk prediction and prognosis for heart failure. They are: MR-proADM (midregional pro adrenomedullin), MR-proANP (midregional pro atrial natriuretic peptide), and CT-proET1 (C-terminal pro endothelin-1). The Company plans to develop three individual diagnostics tests, one per biomarker, which will address different stages of heart failure from diagnosis to survival. The Company commenced feasibility studies for MR-proADM and MR-proANP in March 2014. The Company estimates that the addressable United States market for these tests is similar to that of its PLAC Tests, approximately 36 million lives in 2012.

The Company is also interested in acquiring biomarkers or rights to biomarkers that could be measured at our existing partner cardiovascular specialty laboratories. The Company is specifically interested in assets that would have a development period of three years or less and would help uncover other cardiovascular disease risks.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. In the opinion of management, the accompanying unaudited condensed financial statements have been prepared on a consistent basis with the December 31, 2013 audited financial statements and include all adjustments, consisting of normal recurring adjustments, that are necessary to fairly state the Company’s financial position as of September 30, 2014, results of operations for both the three and nine months ended September 30, 2014 and 2013 and cash flows for the nine months ended September 30, 2014 and 2013.

All references in these notes to financial statements to the “Company,” “we,” “us” and “our” refer to diaDexus, Inc. (f/k/a VaxGen, Inc.), a Delaware corporation, unless the context requires otherwise.

 

2. Summary of Significant Accounting Policies

The Company’s significant accounting policies are disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission (“SEC”) on March 11, 2014, and have not changed as of September 30, 2014.

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Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” The amendment in this ASU provides guidance on the revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The core principle of this update provides guidance to identify the performance obligations under the contract(s) with a customer and how to allocate the transaction price to the performance obligations in the contract. It further provides guidance to recognize revenue when (or as) the entity satisfies a performance obligation. The Company is evaluating the impact of this standard.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15: Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"). The update sets forth a requirement for management to evaluate whether there are conditions and events that raise substantial doubt about an entity's ability to continue as a going concern, a responsibility that did not previously exist in GAAP. The amendments included in this update require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period, including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). ASU 2014-15 will be effective for the Company in fiscal year 2016. The Company is currently assessing the future impact of this update to its financial statements.

 

 

3. Cash and Cash Equivalents

The Company maintains its cash in bank accounts, which at times may exceed federally insured limits. The Company has not experienced any losses on such accounts. The Company considers all highly liquid investments purchased with an original maturity of three months or less at the time of purchase to be cash equivalents.

The following is a summary of cash and cash equivalents at September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

 

 

Fair Value Measurements

In accordance with FASB’s Accounting Standard Codification (“ASC”) 820, the Company discloses and recognizes the fair value of its assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The guidance establishes three levels of the fair value hierarchy as follows:

Level 1: Observable inputs, such as quoted prices in active markets for identical assets or liabilities;

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities;

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Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table represents the Company’s fair value hierarchy for its financial assets (cash and cash equivalents) measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

 

 

The fair value of the notes payable is valued based on Level 2 inputs and approximates its book value. The fair value of the notes payable is based on the present value of expected future cash flows and assumptions about current interest rates and the credit worthiness of the Company. As of September 30, 2014, the notes payable is carried at face value of $15 million less any unamortized debt discount.

The carrying value of other financial instruments, including cash, accounts receivable, accounts payable and other payables, approximates fair value due to their short maturities.

 

4. Inventory

Inventory consists of the following (in thousands):

 

 

 

 

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5. Property, Plant and Equipment

Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized, and maintenance and repairs are charged to expense as incurred. When property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The Company uses other depreciation methods for tax purposes where appropriate. The estimated useful lives for significant property and equipment categories are as follows:

 

 

The following is a summary of property and equipment at cost less accumulated depreciation as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

Depreciation and amortization expense was $125,000 and $405,000 for the three and nine months ended September 30, 2014, respectively, and $135,000 and $401,000, respectively, for the same periods in 2013.

 

6. Total Accrued and Other Current Liabilities

Total accrued and other current liabilities include the following as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

Accrued research obligations represent approximately $0.6 million in payments payable to B.R.A.H.M.S. GmbH, for the license of three heart failure markers. This balance will be settled in March 2015.

 

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7. Concentration of Credit Risk

Revenues from the following customers represented a significant portion of total revenue for the three and nine months ended September 30, 2014 and 2013 and accounts receivable as of September 30, 2014 and December 31, 2013:

 

 

 

8. Notes Payable

In August 2014, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Oxford Finance LLC (“Oxford”) to borrow up to $15 million, the entire amount of which was borrowed at a fixed interest rate of 6.95% per annum. The obligations under the Loan Agreement are payable in 48 monthly installments which began in October 2014, with interest only payments to be made from October 2014 to September 2015, followed by 36 months of equal principal and interest payments. If the Company’s trailing six month revenues equal or exceed $15 million at the end of the fiscal month ending July 31, 2015, the Company may continue to make interest only payments through September 2016 followed by 24 months of equal principal and interest payments. The Company paid an initial fee of $150,000 for access to this loan and will be required to pay an additional $1.5 million following the earlier of loan maturity or termination. The Company may prepay all, but not less than all, of the loan amount with 10 days advance notice to Oxford and payment of a prepayment premium. In connection with the Loan Agreement, the Company issued a warrant to Oxford to purchase 909,090 shares of the Company’s common stock (see Note 12 of these Notes to Condensed Financial Statements).

The Company granted Oxford a security interest in substantially all of the Company’s personal property to secure the Company’s payment and other obligations under the Loan Agreement. The security interest does not extend to patents, trademarks and other intellectual property rights (except for the rights to payment related to the sale, licensing or disposition of such intellectual property rights) or certain other specified property.

The Loan Agreement contains a number of customary representations and warranties and customary covenants, including covenants regarding delivery of financial statements, maintenance of inventory, payment of taxes, maintenance of insurance, dispositions of property, business combinations or acquisitions, incurrence of additional indebtedness and transactions with affiliates. The Company is also restricted from paying dividends or making other distributions or payments of its capital stock except for repurchases of stock pursuant to employee stock purchase plans, employee restricted stock agreements, stockholder rights plans, director or consultant stock option plans, or similar plans, provided such repurchases do not exceed $250,000 in the aggregate per fiscal year. If the Company breaches any of these covenants or it is unable to make a required payment of principal or interest, or it experiences a material adverse change to its business, it could result in a default under the Loan and Security Agreement. As of September 30, 2014, the Company was in compliance with all the covenants.

The Company recorded debt discount of $470,000 associated with the Loan Agreement and the amount will be amortized as interest expense over the term of the Loan Agreement using the effective interest method.

Concurrent with the execution of the Loan Agreement, in August 2014, the Company used $8.1 million of the proceeds received from the loan to repay its existing loan with Comerica Bank. All Loan and Security Agreements previously entered with Comerica Bank were terminated upon receipt of this repayment. The Company was in compliance with all the covenants with Comerica Bank prior to the repayment.

The Company accounted for the repayment to Comerica Bank as a debt extinguishment since the issuance of the new loan is with another unrelated creditor. Accordingly, the Company accelerated and expensed the unamortized debt discount of $132,000, debt issuance costs of $82,000 and balloon payment of $117,000 to interest expense in August 2014.

The Company recorded $81,000 of loss from the debt extinguishment as interest expense. This amount represents a pre-payment premium pursuant to the Amended Loan and Security Agreement entered into with Comerica Bank.

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As of September 30, 2014, future minimum payments for the notes payable are as follows (in thousands):

 

 

 

9. Common Stock

Pursuant to the Company’s restated certificate of incorporation, as amended, the Company is authorized to issue up to 100,000,000 shares of its common stock, par value of $0.01 per share. The holders of common stock are entitled to receive dividends, as, when and if declared by the Company’s Board of Directors out of funds legally available for distribution, subject to the restriction on dividends contained in the Company’s Loan and Security Agreement with Oxford Finance LLC (see Note 8 to these Notes to Condensed Financial Statements).

 

10. Basic and Diluted Net Loss per Share

Basic net loss per common share is based on the weighted average number of common shares outstanding during the period. Diluted net loss per common share is based on the weighted average number of common shares and other dilutive securities outstanding during the period, provided that including these dilutive securities does not increase the net loss per share.

The effect of the options and warrants was anti-dilutive for the nine months ended September 30, 2014 and 2013. The following table shows the total outstanding securities considered anti-dilutive and therefore, excluded from the computation of diluted net loss per share (in thousands):

 

 

 

 

11. Stock Based Compensation

Stock Option Plans

2012 Equity Incentive Award Plan

The Company’s stockholders approved the 2012 Equity Incentive Award Plan (the “2012 Plan”) at the 2012 Annual Meeting of Stockholders on May 17, 2012 and approved 3,000,000 shares of common stock authorized for issuance. Upon approval of the 2012 Plan, all shares of common stock that remained available for issuance under the 1996 Stock Option Plan (the “1996 Plan”) and the 1998 Director Stock Option Plan (the “Director Plan”) were added to the shares reserved under the 2012 Plan. In addition, pursuant to the 2012 Plan, any shares of common stock subject to awards previously granted under the 1996 Plan, the Director Plan and certain non-plan option agreements entered into with certain individuals as of March 31, 2012 that terminate, expire or lapse will become available for issuance under the 2012 Plan. The 2012 Plan was amended at the 2014 Annual Meeting of Stockholders on May 29, 2014 upon stockholder approval of an amendment to the 2012 Plan to increase the number of shares reserved for issuance thereunder by 4,000,000 shares. The 2012 Plan provides for the granting of options, restricted stock awards, restricted stock unit awards (“RSU”), performance awards, dividend equivalents awards, deferred stock awards, deferred stock unit awards, stock payment awards and stock appreciation rights to employees, non-employee directors and consultants. The Company has granted options and RSUs under the

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2012 Plan. Options granted under the 2012 Plan may be designated as qualified or nonqualified at the discretion of the Compensation Committee of the Board of Directors. Generally, shares issuable upon exercise of options vest ratably over four years, beginning one year from the date of grant; however, options can vest upon grant. Option terms expire no later than 10 years from the date of grant, or 5 years from the date the option is granted to a greater than 10% stockholder. The stock options are exercisable at not less than the fair market value of the stock at the date of grant, or not less than 110% of the fair market value of the stock at the date of grant if granted to a greater than 10% stockholder. RSUs granted under the 2012 Plan entitle the recipient to receive one share of the Company’s common stock for every RSU upon vesting. RSUs vest annually. As of September 30, 2014, options to purchase 4,308,656 shares of common stock were outstanding and 5,634,081 shares were available for issuance under the 2012 Plan.

1996 Stock Option Plan

The 1996 Plan initially had 4,750,000 shares of common stock authorized for issuance and a provision that automatically increased this number by 3.5% of the issued and outstanding common stock on the last trading day of the December immediately preceding each fiscal year through January 2007. Options granted under the 1996 Plan were designated as qualified or nonqualified at the discretion of the Compensation Committee of the Board of Directors. Generally, shares issuable upon exercise of options vest ratably over four years, beginning one year from the date of grant; however, options could vest upon grant. All options expire no later than 10 years from the date of grant. Qualified stock options are exercisable at not less than the fair market value of the stock at the date of grant, and nonqualified stock options are exercisable at prices determined at the discretion of the Board of Directors, but not less than 85% of the fair market value of the stock at the date of grant. On May 17, 2012, the 1996 Plan was terminated in connection with the effectiveness of the 2012 Plan. All 1,555,492 shares that were available for issuance under the 1996 Plan were transferred to the 2012 Plan, and the 6,398,904 shares that were subject to awards outstanding under the 1996 Plan remained outstanding pursuant to the terms of the 1996 Plan. As of September 30, 2014, options to purchase 2,633,200 shares of common stock were outstanding pursuant to the terms of the 1996 Plan.

1998 Director Stock Option Plan

The Director Plan for non-employee directors initially had 300,000 shares of common stock authorized for issuance. On May 17, 2012, the Director Plan was terminated in connection with the effectiveness of the 2012 Plan. All 130,000 shares that were available for issuance under the Director Plan were transferred to the 2012 Plan, and the 170,000 shares that were subject to awards outstanding under the Director Plan remained outstanding pursuant to the terms of the Director Plan. As of September 30, 2014, no options were outstanding pursuant to the terms of the Director Plan.

Non-Plan Grants

In October 2004, the Company granted non-qualified stock options to purchase 30,000 shares of common stock outside of the Company’s stock option plans to its former director with an exercise price of $12.27 per share. These options were granted with terms that are substantially in accordance with the Company’s standard stock option terms. As of September 30, 2014, all of these options remained outstanding.

In September 2011, the Company granted non-qualified stock options to purchase 1,530,000 shares of common stock outside of the Company’s stock option plans to its current Chief Executive Officer with an exercise price of $0.25 per share. These options were granted with terms that are substantially in accordance with the Company’s standard stock option terms. As of September 30, 2014, all of these options remained outstanding.

In October 2011, the Company granted non-qualified stock options to purchase 1,130,000 shares of common stock outside of the Company’s stock option plans to its current Chief Business Officer with an exercise price of $0.26 per share. These options were granted with terms that are substantially in accordance with the Company’s standard stock option terms. As of September 30, 2014, 712,416 of these options remained outstanding.

On February 1, 2012, the Company granted non-qualified stock options to purchase 1,060,000 shares of common stock outside of the Company’s stock option plans to its current Chief Financial Officer with an exercise price of $0.28 per share. These options were granted with terms that are substantially in accordance with the Company’s standard stock option terms. As of September 30, 2014, 679,935 of these options remained outstanding.

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Restricted Stock Units

On August 6, 2013, the Company awarded an aggregate of 41,708 RSUs to its non-employee directors with a grant-date fair value equal to approximately $55,000 in the aggregate. Each RSU entitled the recipient to receive one share of the Company’s common stock upon vesting. The RSUs awarded to the non-employee directors vested in full on July 1, 2014. The fair value of nonvested RSUs is based on the Company’s closing stock price on the date of grant. As of September 30, 2014, no RSUs remained outstanding. A summary for the nine months ended September 30, 2014 is as follows:

 

 

The following table summarizes stock compensation expense related to employee stock options and employee stock-based compensation for the three and nine months ended September 30, 2014 and 2013, which was incurred as follows (in thousands):

 

 

Stock-based compensation expense recognized during the three and nine months ended September 30, 2014 and 2013 includes compensation expense for stock-based awards granted to employees based on the grant date fair value estimated in accordance with the provisions of ASC 718. As of September 30, 2014, the total remaining unrecognized cost was approximately $1.2 million to be recognized over approximately three years.

Valuation Assumptions

The compensation expense related to stock options recognized was determined using the Black-Scholes option valuation model. Option valuation models require the input of subjective assumptions and these assumptions can vary over time. The weighted average assumptions used were as follows:

 

 

For the three and nine months ended September 30, 2014, the volatility assumption was determined by the trading history for the Company. Prior to 2014, the Company did not have sufficient trading history for its common stock and its volatility assumption was determined by examining the historical volatilities for industry peers and the trading history for the Company’s common stock. The Company will continue to use its historical stock price volatility and expected term assumption for future periods. The risk-free interest rate assumption is based on the U.S. Treasury instruments whose term was consistent with the expected term of the Company’s stock options. The expected dividend assumption is based on the Company’s history and expectation of dividend payouts. Different estimates of volatility and expected term could materially change the value of an option and the resulting expense. The

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expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding and is based on the options vesting terms, contractual terms and historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior.

Employee Stock-Based Compensation

The table below presents information related to stock option activity for the nine months ended September 30, 2014, as follows:

 

 

 

 

12. Stock Warrants

The Company issues warrants to investors as part of its overall financing strategy and to vendors in order to reduce costs. In connection with the Loan and Security Agreement the Company entered into with Comerica in September 2011 (see Note 8 to these Notes to Condensed Financial Statements), the Company issued a warrant to purchase 480,769 shares of the Company’s common stock, at an exercise price of $0.26 per share and with an expiration date in September 2018. The initial fair value of the warrant was calculated using the Black-Scholes option pricing model and the following assumptions: volatility of 88.03%, risk-free interest rate of 1.36%, exercise price of $0.26 and an expected life of 7 years. The fair value of the warrant was determined to be $94,000 and was recorded as equity in additional paid-in-capital and a discount to the carrying value of the loan. Through August 2012, the discount was amortized to interest expense using the effective interest rate method over the 48-month term of the original loan. Beginning in September 2012 in connection with the First Amended Loan and Security Agreement between the Company and Comerica, and continuing in October 2013 with the Second Amended Loan and Security Agreement between the Company and Comerica (see Note 8 to these Notes to Condensed Financial Statements), the unamortized discounts were being recognized over the remaining term of the amended loan, based on a maturity date of December 2016, until it was terminated in August 2014. The unamortized amount was accelerated and expensed to interest expense upon the repayment.

In connection with the First Amended Loan and Security Agreement with Comerica, the Company issued Comerica a warrant to purchase 168,919 shares of the Company’s common stock, at an exercise price of $0.37 per share. This warrant expires in September 2019. The initial fair value of the warrant was calculated using the Black-Scholes option pricing model and the following assumptions: volatility of 89.87%, risk-free interest rate of 1.03%, exercise price of $0.37 and an expected life of 7 years. The fair value of the warrant was determined to be $48,000 and was recorded as equity in additional paid-in-capital and a discount to the carrying value of the loan. The discount was amortized to interest expense using the effective interest rate method over the remaining term of the amended loan, based on a maturity date of September 2016, until it was terminated in August 2014. The unamortized amount was accelerated and expensed to interest expense upon the repayment.

In connection with the Second Amended Loan and Security Agreement with Comerica, the Company issued Comerica a warrant to purchase 96,685 shares of the Company’s common stock, at an exercise price of $1.81 per share. This warrant expires in October 2020. The initial fair value of the warrant was calculated using the Black-Scholes option pricing model and the following assumptions: volatility of 89.01%, risk-free interest rate of 2.05%, exercise price of $1.81 and an expected life of 7 years. The fair value of the warrant was determined to be $136,000 and was recorded as equity in additional paid-in-capital and a discount to the carrying value of the loan. The discount was amortized to interest expense using the effective interest rate method over the remaining term of the amended loan, based on a maturity date of December 2016, until it was terminated in August 2014. The unamortized amount was accelerated and expensed to interest expense upon repayment.

In connection with the Loan and Security Agreement the Company entered into with Oxford Finance LLC in August 2014 (see Note 8 to these Notes to Condensed Financial Statements), the Company issued Oxford a warrant to purchase 909,090 shares of the Company’s common stock, at an exercise price of $0.66 per share and with an expiration date in August 2021. The initial fair value of

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the warrant was calculated using the Black-Scholes option pricing model and the following assumptions: volatility of 90.29%, risk-free interest rate of 2.06%, exercise price of $0.66 and expected life of 7 years. The fair value of the warrant was determined to be $470,000 and was recorded as equity in additional paid-in-capital and a discount to the carrying value of the loan. The discount is being amortized to interest expense using the effective interest rate method over the remaining term of the loan which matures in September 2018.

In August 2013, the Company issued 386,784 shares of common stock pursuant to a cashless exercise of Comerica’s warrant to purchase 480,769 shares at an exercise price of $0.26 per share.

As of September 30, 2014, there were warrants outstanding to purchase 1,174,694 shares of the Company’s common stock, with a weighted-average exercise price of $0.71 per share and an aggregate exercise price of $837,000.

The following table summarizes information about all warrants outstanding as of September 30, 2014:

 

 

13. Restructuring and Other Charges

During 2014, the Company entered into several transition agreements with certain key employees including its Chief Executive Officer and Chief Business Officer.

As of September 30, 2014, the Company has incurred $505,000 in restructuring and other charges under these agreements. The following table summarizes changes in the restructuring accrual for the three and nine months ended September 30, 2014 (in thousands):

 

 

During the three months ended September 30, 2014, the Company incurred $396,000 in employee severance costs and $36,000 in other costs. These costs are recorded in operating expenses in the Condensed Statements of Comprehensive Loss and the associated liabilities are recorded in accrued and other current liabilities in the Condensed Balance Sheets. The Company paid $45,000 in employee severance costs and $8,000 in other costs.

 

During the nine months ended September 30, 2014, the Company incurred $456,000 in employee severance costs and $49,000 in other costs. These costs are recorded in operating expenses in the Condensed Statements of Comprehensive Loss and the associated liabilities are recorded in accrued and other current liabilities in the Condensed Balance Sheets. The Company paid $45,000 in employee severance costs and $8,000 in other costs.

As of September 30, 2014, the entire balance of $452,000 in restructuring accrual was classified as short-term and recorded within accrued and other current liabilities in the Condensed Balance Sheet. The Company is expected to record approximately $251,000 in the fourth quarter of 2014 relating to these agreements.

 

 

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14. Commitments and Contingencies

Lease Commitments

The Company leases an office and laboratory facility (the “349 Facility”) under a long-term, non-cancelable operating lease agreement, which expires in December 2016.

In 2010, the Company recorded a lease obligation associated with the 349 Facility, which contained a lease payment that exceeded current market rates. Accordingly, the Company recognized a $4.1 million unfavorable lease obligation, included in the accompanying balance sheet. The Company amortizes the unfavorable lease obligation using the effective interest rate method.

Rent expense for the Company’s facilities was $456,000 and $1.4 million for the three and nine months ended September 30, 2014, respectively, and $484,000 and $1.5 million, respectively, for the same periods in 2013. The terms of the lease for the 349 Facility provides for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period. Deferred rent of $349,000 and $387,000 at September 30, 2014 and December 31, 2013, respectively, is included in the accompanying balance sheets.

As of September 30, 2014, future minimum lease payments under non-cancelable operating leases are as follows (in thousands):

 

Research and Development Commitments and Contingencies

In March 2014, the Company entered into a License and Supply Agreement (the “Agreement”) with B.R.A.H.M.S. GmbH. Under the terms of the Agreement, the Company paid €750,000 in April 2014 and it is obligated to pay another €500,000 in March 2015. The Company may pay up to €600,000 in development and regulatory milestones and post-launch commercial milestones up to a total of €1,000,000.

 

15. Income Taxes

Provision for Income Tax

The Company’s effective tax rate is 0% for income tax for the nine months ended September 30, 2014 and the Company expects that its effective tax rate for the full year 2014 will be 0%. Based on the weight of available evidence, including cumulative losses since inception and expected future losses, the Company has determined that it is more likely than not that the deferred tax asset amount will not be realized and therefore a valuation allowance has been provided on net deferred tax assets.

Under the provisions of Section 382 and 383 of the Internal Revenue Code (the “Code”), a change of control, as defined in the Code, may impose an annual limitation on the amount of the Company’s net operating loss and tax credit carryforwards, and other tax attributes, that can be used to reduce future tax liabilities.

The Company files U.S. Federal and multiple state tax returns. The Company is currently not subject to any income tax examinations. Due to the Company’s losses, generally all years remain open.

Uncertain Tax Positions

Effective January 1, 2009, the Company adopted ASC 740-10, which requires that the Company recognize the financial statement effects of a tax position when it becomes more likely than not, based upon the technical merits, that the position will be sustained upon examination.

The gross amount of unrecognized tax benefits as of September 30, 2014 is $1.6 million related to the reserve on R&D credits, none of which will affect the effective tax rate if recognized due to the valuation allowance. The Company does not expect any material changes in the next 12 months in unrecognized tax benefits.

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The Company recognizes interest and/or penalties related to uncertain tax positions. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected in the period that such determination is made. The interest and penalties are recognized as other expense and not tax expense. The Company currently has no interest and penalties related to uncertain tax positions.

 

16. Subsequent Events

In the fourth quarter of 2014, the Company started realigning its operational structure to support its objectives in 2015 and beyond. In connection with these initiatives, the Company plans to reduce and reallocate its staff in the fourth quarter and the one-time charges arising from this restructuring are not expected to be significant to the Company's 2014 financial statements. 

 

 

 

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The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve a number of risks and uncertainties. Our actual results could differ materially from those indicated by forward-looking statements as a result of various factors, including but not limited to, the period for which we estimate our cash resources are sufficient, the availability of additional funds, as well as those set forth under “Risk Factors” and those that may be identified from time to time in our reports and registration statements filed with the Securities and Exchange Commission.

The following discussion and analysis is intended to provide an investor with a narrative of our financial results and an evaluation of our financial condition and results of operations. This discussion should be read in conjunction with the unaudited Condensed Financial Statements and related Notes included in Item 1 of this Quarterly Report and the Financial Statements and related Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

Overview

We are a life sciences company focused on developing and commercializing proprietary cardiovascular diagnostic products addressing unmet needs in cardiovascular disease (“CVD”). We sell our diagnostic products to laboratories. Physicians order testing for their patients from these laboratories and use the results to aid in assessing their patients risk for CVD.

Our company was initially incorporated in November 1995. In July 2010, we completed a reverse merger with former diaDexus, Inc., which was the successor to a company initially formed as a joint venture between SmithKlineBeecham Corporation (now GlaxoSmithKline LLC (“GlaxoSmithKline”)) and Incyte Pharmaceuticals, Inc. Upon formation in September 1997, SmithKlineBeecham Corporation granted former diaDexus, Inc. an exclusive license to certain diagnostic intellectual property, including exclusive rights to develop diagnostic assays for lipoprotein-associated phospholipase A2 (“Lp-PLA₂”). In November 2010, in connection with the reverse merger, we changed our name to diaDexus, Inc.

Our PLAC Tests products, are designed to provide information, over and above traditional risk factors, such as cholesterol levels, to help identify individuals at increased risk of suffering a heart attack or stroke. Some of these events may be reduced with earlier detection of increased risk and more aggressive risk-reducing strategies, including treatment to lower LDL-cholesterol goals with statins. We have commercialized two PLAC Tests. One test, the PLAC Test ELISA Kit (the “PLAC ELISA Test”), measures the mass of circulating Lp-PLA₂ in the blood using an enzyme-linked-immunosorbent serologic assay (“ELISA”). The PLAC ELISA Test is the only Lp-PLA₂ blood test cleared by the Food and Drug Administration (“FDA”) to aid in assessing risk for both coronary heart disease (“CHD”) and ischemic stroke associated with atherosclerosis. The second test, the PLAC Test for Lp-PLA₂ Activity (the “PLAC Activity Test”), is an enzyme assay for the quantitative determination of Lp-PLA₂ activity levels in human plasma and serum on automated clinical chemistry analyzers, to be used in conjunction with clinical evaluation and patient risk assessment as an indicator of atherosclerotic cardiovascular disease.

There are several published clinical studies that provide preliminary evidence that Lp-PLA₂ levels may have clinical utility in diseases or indications other than those for which our PLAC Tests are currently cleared. We intend to focus on cardiovascular disease risks, such as risks of secondary cardiac events and risks of cardiac events in the context of other diseases.

In March 2014, we entered into an agreement to license the rights to develop and commercialize three independent biomarkers (MR-proADM (midregional pro adrenomedullin), MR-proANP (midregional pro atrial natriuretic peptide), and CT-proET1 (C-terminal pro endothelin-1) to aid in risk prediction and prognosis for heart failure. We plan to develop three individual diagnostics tests, one per biomarker, which may address different stages of heart failure from prediction, diagnosis and survival. We estimate that the addressable U.S. market for these tests is similar to that of our PLAC Tests, or approximately 36 million lives in 2012.

We are also interested in acquiring biomarkers or rights to biomarkers that could be sold through our existing partnered sales channel, i.e., measured at cardiovascular specialty laboratories. We are specifically interested in assets that would have a development period of three years or less and would help uncover other heart disease risks.

We have incurred substantial losses since inception, and expect to continue to incur net losses for at least the next few years based on our current plans to engage in new development activities to broaden or enhance our product pipeline. To date, we have funded our operations primarily through private placements of equity and debt financing, as well as through revenue generated from the sale of products.

We entered into a Loan and Security Agreement with Oxford Finance LLC in August 2014 (see Note 8 to the Notes to Condensed Financial Statements included in this report). The Loan and Security Agreement contains certain customary representations and warranties and customary affirmative and negative covenants. Our future liquidity requirements may increase beyond currently

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expected levels if we fail to maintain compliance with such covenants. In order to meet our future liquidity needs, we may become reliant on additional equity and/or debt financing. Additional funding may not be available when needed or on terms acceptable to us. The consent of Oxford Finance LLC will likely be required for additional debt financings. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants and security interests in our assets. We cannot assure you that we will be able to raise any such additional funding in a timely manner if we require funds.

In the fourth quarter of 2014, we started realigning our operational structure to support our objectives in 2015 and beyond. In connection with these initiatives, we plan to reduce and reallocate our staff in the fourth quarter and the one-time charges arising from this restructuring are not expected to be significant to our 2014 financial statements. These initiatives are expected to result in a reduction in our operating expense level in 2015.

The terms “Company,” “diaDexus,” “we,” “us,” and “our” refer to the business of diaDexus, Inc. (f/k/a VaxGen, Inc.) after the reverse merger between Vaxgen, Inc. and former diaDexus, Inc. on July 28, 2010.

Critical Accounting Policies and Estimates

The accompanying discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses, and related disclosures. On an ongoing basis, we evaluate these estimates. Estimates are based on historical experience, information received from third parties and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from those estimates under different assumptions or conditions.

Critical accounting estimates, as defined by the Securities and Exchange Commission (“SEC”), are those that are most important to the portrayal of our financial condition and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. The accounting policies and estimates that we consider to be critical, subjective, and requiring judgment in their application are summarized in “Item 7-Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with SEC on March 11, 2014. There have been no significant changes to the accounting policies and estimates disclosed in our Form 10-K.

Results of Operations

For the Three and Nine Months Ended September 30, 2014 and 2013.

Revenues

 

 

Revenues by geography are based on the billing address of the customer. The following table sets forth total revenues by geographic area (in thousands):

 

 

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Revenues are generated from product sales, service revenue, licensing fees, and royalties earned. The accounting classification of product revenue as either royalties or product sales relates to the sales channels we use, and as such, we believe that operating performance is most effectively evaluated by examining total revenues. Service revenue relates to laboratory services under an agreement with GlaxoSmithKline.

The increase in total revenues of approximately $954,000 for the three months ended September 30, 2014 as compared to the same period in 2013 is primarily due to revenues from laboratory services performed for GlaxoSmithKline of approximately $2.2 million, offset by decrease in product sales of approximately $1.3 million due to decreased volume demand for our PLAC ELISA Test.

The increase in total revenues of approximately $2.3 million for the nine months ended September 30, 2014 as compared to the same period in 2013 is primarily due to revenues from laboratory services performed for GlaxoSmithKline of approximately $3.6 million, offset by decrease in product sales of approximately $1.3 million due to decreased volume demand for our PLAC ELISA Test.

Our top five customers accounted for 81% and 78% of our total revenues for the three and nine months ended September 30, 2014, respectively, compared to 81% and 77%, respectively, for the same periods in 2013. Because of this customer concentration and the timing of orders from these customers, our quarterly revenues through the end of 2014 may fluctuate materially.

Operating Costs and Expenses

Product Costs

 

 

Product costs include our expenditures for cost of goods, manufacturing support, product supplies, quality control, personnel expenses and facility costs. Product costs increased $28,000 for the three months ended September 30, 2014 as compared to the same period in 2013. This increase was primarily due to an increase of approximately $176,000 related to production of pilot lots of our PLAC Activity Test, partly offset by a decrease in PLAC Tests production costs of approximately $112,000 due to lower sales volume, decrease in manufacturing related costs of approximately $22,000 due to improvements in manufacturing processes, and a decrease of approximately $14,000 due to reduction in the effective excise tax cost.

Product costs decreased $284,000 for the nine months ended September 30, 2014 as compared to the same period in 2013. This decrease primarily reflects a decrease in PLAC Tests production costs of approximately $196,000 due to lower sales volume, a decrease in manufacturing related costs of $123,000 due to improvements in manufacturing processes, a decrease in recruiting costs of approximately $108,000 related to hiring in quality control and manufacturing in 2013, a decrease of approximately $74,000 due to reduction in the effective excise tax cost, partly offset by an increase of approximately $208,000 related to production of pilot lots of our PLAC Activity Test.

Service costs

 

Service costs include our expenditures such as personnel and temporary support staff expenses, and lab supply costs. Service costs increased $333,000 and $520,000 for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013. This increase reflects expenses incurred in conjunction with providing laboratory services to GlaxoSmithKline.

 

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Sales and Marketing Expenses

 

 

Sales and marketing expenses include our expenditures on customer support, medical and other consultant fees, marketing programs and materials, and personnel expenses. Sales and marketing expenses increased $951,000 for the three months ended September 30, 2014 as compared to the same period in 2013. This increase primarily reflects an increase in personnel expenses of approximately $398,000 due to the doubling of our sales and marketing team in first quarter 2014, an increase of approximately $319,000 related to the development of marketing materials and increase in physician education programs, an increase in restructuring costs of approximately $210,000 related to departure of key personnel, and an increase in travel and entertainment costs of approximately $16,000 due to higher headcount.

Sales and marketing expenses increased $2.2 million for the nine months ended September 30, 2014 as compared to the same period in 2013. The increase primarily reflects an increase in personnel expenses of approximately $1.1 million due to an expansion of our sales and marketing team, an increase of approximately $682,000 related to the development of marketing materials and increase in physician education programs, an increase in restructuring costs of approximately $174,000 primarily due to departure of key personnel, an increase in travel and entertainment costs of approximately $109,000 due to higher headcount, and an increase in office costs of approximately $70,000 to support expansion of our sales and marketing teams.

We expect our sales and marketing expenses to continue to increase as we develop and commercialize new pipeline diagnostic products to maintain and expand our position in the market for diagnostics in CVD.

Research and Development Expenses

 

 

Research and development expenses include costs related to product development, regulatory support of our technology and other technical support costs, including salaries and consultant fees. Research and development expenses decreased $273,000 for the three months ended September 30, 2014 as compared to the same period in 2013. This decrease primarily reflects a decrease of approximately $152,000 in personnel costs due to reallocation of our resources to provide laboratory services to GlaxoSmithKline, and a decrease in consulting expense of approximately $128,000 primarily related to our FDA regulatory filing for our PLAC Activity Test.

Research and development expenses increased $1.8 million for the nine months ended September 30, 2014 as compared to the same period in 2013. This increase primarily reflects an increase in expenses related to the development of our product pipeline of approximately $1.8 million which includes an initial payment to obtain an exclusive license from B.R.A.H.M.S. GmbH (“BRAHMS”) related to certain heart failure biomarkers.  

We expect to incur additional research and development expenses in the future pursuant to the terms of the BRAHMS license agreement. We also expect research and development expenses to increase in the future as a result of staffing increases and expansion of our product pipeline development projects.

General and Administrative Expenses

 

 

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General and administrative expenses include personnel costs for finance, administration, information systems and professional fees as well as facilities expenses. General and administrative expenses increased $603,000 for the three months ended September 30, 2014 as compared to the same period in 2013. This increase primarily reflects an increase in restructuring costs of approximately $248,000 related to the departure of key personnel, an increase in professional fees of approximately $301,000 primarily related to increases in legal fees, filings of patent applications, and recruiting fees, and an increase in stock-based compensation of approximately $63,000 primarily attributable to a higher stock price.

General and administrative expenses increased $1.2 million for the nine months ended September 30, 2014 as compared to the same period in 2013. This increase primarily reflects an increase in professional fees of approximately $702,000 primarily related to increases in legal fees, filing of patent applications and recruiting fees, an increase in restructuring costs of approximately $320,000 related to the departure of key personnel, and an increase in stock-based compensation of approximately $209,000 primarily attributable to a higher stock price, partly offset by a decrease in travel and entertainment of approximately $30,000.

We expect general and administrative expenses to increase as a result of the expansion of our leadership team.

Interest Income, Interest Expense and Other Income (Expense), net

 

Interest income is derived from cash balances and short-term and long-term investments. Interest expense is based on outstanding debt obligations. Total interest and other income (expense) increased $581,000 for the three months ended September 30, 2014 as compared to the same period in 2013. This increase primarily reflects an increase in interest expense of approximately $636,000 due to the termination of our credit facility with Comerica and our repayment in full of the outstanding loan.

Total interest and other income (expense) decreased $1.2 million for the nine months ended September 30, 2014 as compared to the same period in 2013. This decrease primarily reflects a gain of approximately $347,000 from the sale of assets held for sale in 2013, and an increase in interest expense of approximately $875,000 primarily due to the termination of our credit facility with Comerica and our repayment in full of the outstanding loan. This increase in interest expense also includes $87,000 from loss of extinguishment for the Comerica loan.

In August 2014, we entered into a new credit facility with Oxford Finance LLC. Interest expense under our new credit facility will continue as long as the loan is outstanding and will decrease as the loan is repaid.

Income Taxes

 

 

We generated net loss for the three and nine months ended September 30, 2014 and had no federal income tax provision. Our effective tax rate was 0% for income tax for each of the three and nine months ended September 30, 2014 and we expect that our effective tax rate for the full year 2014 will be 0%. In addition, we have substantial net operating loss carry forwards available to offset future taxable income for federal and state income tax purposes. At September 30, 2014, we had unrecognized tax benefits totaling $1.6 million. Our ability to utilize our net operating losses may be limited due to changes in our ownership as defined by Section 382 of the Internal Revenue Code (the “Code”).

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Under the provisions of Sections 382 and 383 of the Code, a change of control, as defined in the Code, may impose an annual limitation on the amount of the Company’s net operating loss and tax credit carryforwards, and other tax attributes that can be used to reduce future tax liabilities. As a result of a merger transaction involving us in 2010, certain of our tax attributes prior to the merger transaction are subject to an annual limitation of $240,000 for federal and state purposes.

Liquidity and Capital Resources

Since our inception, we have incurred losses, and we have relied primarily on private placements of preferred stock and debt financing, as well as on revenue generated from the sale of products, to fund our operations. As of September 30, 2014, we had an accumulated deficit of $206.1 million, working capital of $16.7 million and stockholders’ equity of $2.5 million. Based on our current operating plan, we believe that our existing cash, cash equivalents, and investment securities will be sufficient to cover our cash needs for operating activities and commitments for at least twelve months.

Cash and Cash Equivalents

As of September 30, 2014, we had cash and cash equivalents of $15.9 million, compared to $16.8 million at December 31, 2013. The decrease of $0.9 million primarily reflects cash used in operating activities of $5.8 million and net proceeds from the notes payable under our credit facility with Oxford of $4.8 million.

Cash Flows from Operating Activities

Net cash used in operating activities was $5.8 million for the nine months ended September 30, 2014, and was primarily related to the net loss of $6.2 million and $444,000 in cash outflow related to changes in operating assets and liabilities. This was partially offset by non-cash items totaling 819,000. Significant non-cash items were $596,000 in stock-based compensation, $405,000 in depreciation and amortization, $311,000 in non-cash interest associated with our term loan and $(516,000) in unfavorable lease amortization.

Net cash used in operating activities was $1.9 million for the nine months ended September 30, 2013, and was primarily related to the net loss of $2.0 million and $85,000 in cash outflow related to changes in operating assets and liabilities. Significant non-cash items were $(340,000) of gain in sale of equipment, $(436,000) in unfavorable lease amortization, $401,000 in depreciation and amortization, $432,000 in stock-based compensation and $98,000 in noncash interest.

Cash Flows from Investing Activities

Net cash used in investing activities in the nine months ended September 30, 2014 was $183,000, primarily representing purchases of property and equipment.

Net cash provided by investing activities in the nine months ended September 30, 2013 was $1.2 million, primarily due to net investment maturities of $747,000 and proceeds from sale of equipment of $640,000. This cash provided by investing activities was partially offset by $207,000 in purchases of property and equipment.

Cash Flows from Financing Activities

Net cash used in financing activities in the nine months ended September 30, 2014 was $5.0 million primarily due to borrowings under our new credit facility with Oxford in the amount of $15.0 million and stock option exercises of $162,000. This was partially offset by $10.0 million in repayment of principal of our previous loan with Comerica and $191,000 in loan issuance costs related to the Oxford loan.

Net cash provided by financing activities in the nine months ended September 30, 2013 of $45,000 consisted entirely of proceeds from stock option exercises.

Other Information

Our future capital requirements will depend primarily upon our ability to maintain and grow our current product revenues, to obtain regulatory approval for the PLAC Activity Test in the US, to develop and commercialize product line extensions for our PLAC Tests, to develop or acquire new cardiovascular biomarker tests, to manage our obligations under real estate leases, and to improve our reimbursement prospects from third-party payors.

We have incurred substantial losses since inception, and expect to continue to incur net losses for at least the next few years based on our current plans to engage in new development activities to broaden or enhance our product pipeline. To date, we have funded our

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operations primarily through private placements of preferred stock and debt financing, as well as through revenue generated from the sale of products.

In August 2014, we entered into a Loan and Security Agreement with Oxford Finance LLC (see Note 8 of the Notes to Condensed Financial Statements included in this report). This agreement contains various affirmative and negative covenants. If we breach any of these covenants or we are unable to make a required payment of principal or interest, or we experience a material adverse change to our business, it could result in a default under the Loan and Security Agreement. If we are unable to repay the amounts due under the Loan and Security Agreement, the lender could proceed against the collateral granted to it to secure such indebtedness. We have pledged substantially all of our assets, other than our intellectual property, as collateral under the loan.

Our future liquidity requirements may increase beyond currently expected levels if we fail to maintain compliance with the loan covenants. In order to meet our future liquidity needs, we expect to require additional financing and will seek to raise funds through equity or debt offerings, bank facilities, or other sources of capital. Additional funding may not be available when needed or on terms acceptable to us. The consent of Oxford Finance LLC will likely be required for additional debt financings. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. We cannot assure you that we will be able to raise any such additional funding or, if available, that such funding would be on favorable terms.

Commitments and Contingencies

Our contractual obligations and future minimum lease payments that are non-cancelable at September 30, 2014 are disclosed in the following table (in thousands):

 

As part of the reverse merger completed in 2010, we recorded a lease obligation which contained a lease payment that exceeded current market rates. Accordingly, we recognized a $4.1 million unfavorable lease obligation. We amortize the unfavorable lease obligation using the effective interest rate method. The carrying amount of the unfavorable lease liability was $2.0 million as of September 30, 2014.

In March 2014, we entered into a License and Supply Agreement (the “Agreement”) with B.R.A.H.M.S. GmbH. Under the terms of the Agreement, we paid €750,000 (or $1.4 million) in April 2014 and we are obligated to pay another €500,000 (or $639,000 as of September 30, 2014) in March 2015. We may pay up to €600,000 (or $767,000 as of September 30, 2014) in development and regulatory milestones and post-launch commercial milestones up to a total of €1,000,000 (or $1.3 million as of September 30, 2014).

Off-Balance Sheet Arrangements

As of September 30, 2014, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Recent Accounting Pronouncements

See Note 2 of our Notes to Condensed Financial Statements included in this report for recent accounting pronouncements, including the expected dates of adoption and estimated effects on our financial statements.

 

In the normal course of business, our financial position is routinely subject to a variety of risks, including market risk associated with interest rate movement. We regularly assess these risks and have established policies and business practices intended to protect against these and other exposures. As a result, we do not anticipate material potential losses in these areas.

As of September 30, 2014, we had cash and cash equivalents of $15.9 million, which consisted of cash and highly liquid money market funds.

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During the nine months ended September 30, 2014, there were no material changes to our market risk disclosures as set forth in Part II Item 7A. “Quantitative and Qualitative Disclosure About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

Evaluation of Disclosure Controls and Procedures

We have performed an evaluation under the supervision and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, our management, including our principal executive and principal financial officers, concluded that our disclosure controls and procedures were effective as of September 30, 2014 to provide reasonable assurance that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal Controls

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our disclosure controls and procedures and internal control over financial reporting may not prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Projections of any evaluation of the effectiveness of a control system to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure system are met.

 

 

 

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PART II – OTHER INFORMATION

 

The Company is from time to time subject to various claims and legal actions during the ordinary course of business. The Company believes that there are currently no claims or legal actions that would reasonably be expected to have a material adverse effect on its results of operations or financial condition.

 

Investing in our common stock involves a very high degree of risk. You should carefully consider the risks described below and all of the other information in our filings under the Exchange Act before making any investment decisions regarding our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we do not know of or that we currently deem immaterial may also negatively affect our business, financial condition, operating results, and prospects. In that case, the market price of our common stock could decline, and you could lose all or part of your investment.

Risks Relating to Our Business Operations

We may not be able to obtain clearance from the FDA for our 510(k) application for our PLAC Activity Test.

In June 2011, we submitted a premarket notification to the FDA seeking clearance under Section 510(k) of the Food, Drug and Cosmetic Act, (“FDCA”) to market our PLAC Activity Test. This assay measures the activity levels of the Lp-PLA₂ enzyme in the blood, while the PLAC ELISA Test currently marketed in the US utilizes an ELISA method that measures the concentration of the enzyme. The PLAC Activity Test is capable of running on automated, high throughput clinical chemistry analyzers unlike the current PLAC ELISA Test. Future commercialization of an assay capable of running on automated, high throughput clinical chemistry analyzers may be important for the expansion of the PLAC Tests market and our revenue growth. On October 24, 2011, we elected to withdraw this application following discussions with the FDA. We continued to have discussions with the FDA regarding a new application for the PLAC Activity Test, and in September 2013, we had a pre-submission meeting with the FDA. As a result of this meeting, we advanced our clinical program to support the submission of the PLAC Activity Test. We partnered with REGARDS, a large longitudinal cardiovascular disease study to validate the PLAC Activity Test and we completed the study sample analysis in the first quarter of 2014. We submitted a 510(k) application with the FDA in June 2014, which was accepted for substantive review in July 2014.

There can be no guarantee that our clinical trials or the results of any such clinical trials will be satisfactory to the FDA. We are unable to predict when or if we may receive clearance for the PLAC Activity Test, which may result in a loss of potential customers and would have an adverse effect on our financial condition and our ability to maintain or expand our business.

Even if we obtain FDA clearance of our 510(k) application for our PLAC Activity Test, we may not be able to successfully commercialize our PLAC Activity Test in the US.

Even if we obtain FDA clearance to commercialize our PLAC Activity Test in the US, we may not have the resources and ability to successfully launch the product. We will require significant resources to effectively manufacture, market and sell our PLAC Activity Test.  Failure to execute our strategy to commercialize the PLAC Activity Test may have a material adverse effect on our business, operating results, cash flows and financial condition.

Our future success depends on our ability to effectively recruit and retain our senior management and other key employees and attract, retain and motivate qualified personnel.

We depend on the efforts and abilities of our senior management, our research and development staff and a number of other key management, sales, support, technical and administrative services personnel. In particular, we rely on the experience of our senior management, who have specific knowledge of our business and industry that is difficult to replace. If we are unable to attract and retain highly-qualified senior management our business may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. As previously announced, our current Chief Executive Officer plans to retire from diaDexus by the end of 2014, and our current chairman of the board will act as the interim executive chair until a successor is named. In addition, our Chief Financial Officer and Chief Business Officer both resigned from the company in September 2014. We also appointed a new President in August 2014 and a Chief Medical Officer and interim Chief Commercial Officer in September 2014. Any failure to effectively manage these transitions or retain these new executives and other members of our senior management team could be disruptive to our business operations and have an adverse effect on the execution of our business strategies, as well as our potential to raise capital.

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Competition for experienced, high-quality personnel exists, particularly in the San Francisco Bay Area, and we cannot assure you that we can continue to recruit and retain such personnel. Our failure to hire, train and retain qualified personnel would impair our ability to develop new products and manage our business effectively.

We are an early stage company and have engaged in only limited sales and marketing activities for our first products, the PLAC Tests.

Our products may never gain significant acceptance in the marketplace and therefore never generate substantial revenue or profits. As is the case with all novel biomarkers, we must establish a market for our PLAC Tests and build that market through physician education and awareness programs. Publication in peer review journals of results from outcome studies using our products will be an important consideration in the adoption by physicians and in the coverage by insurers. Our ability to successfully commercialize the PLAC Tests and other diagnostic products will depend on many factors, including:

These and other factors may present obstacles to commercial acceptance of our products, and we may need to devote substantial time and money to surmount these obstacles, and the result might not be successful.

Our business is characterized by a high degree of customer concentration. The loss of one or more of these customers or a decline in revenue from one or more of our key customers could have a material adverse effect on our business, financial condition, and results of operations.

Sales to a limited number of customers account for a significant portion of our revenue and accounts receivable. Our top five customers accounted for 81% and 75% of our accounts receivable as of September 30, 2014 and December 31, 2013, respectively, and 78% of our total revenues for both the nine months ended September 30, 2014 and 2013. Our dependence on and the identity of our key customers may vary from period to period as a result of competition among our customers, developments related to our products, and changes in individual customers’ purchases of our products. We may experience greater or lesser customer concentration in the future, depending on future commercial agreements and whether we are able to grow our revenue from the PLAC Activity Test. However, it is likely that our revenues and profitability will continue to be dependent on a very limited number of customers, and we may experience an even higher degree of customer concentration in the future. The loss of, material reduction in sales volume to, or significant adverse change in our relationship with any of our key customers could have a material adverse effect on our revenue in any given period and may result in significant annual and quarterly revenue variations. Moreover, our largest customers exert greater influence over our product pricing, which led to a decline in average sales price in past quarters. Such downward pressure on our pricing may continue. In addition, we may be unable to collect related accounts receivables when due, which could have a material adverse effect on our business.

In June 2014, the Office of Inspector General (“OIG”) published a special fraud alert relating to compensation paid by laboratories to referring physicians and physician group practices for blood specimen collection, processing and packaging, and for submitting patient data to a registry or database. The publication is an industry notification posted on the OIG website. This further guidance from the OIG may have an adverse effect on sales to our customers as the alert could reduce the number of tests ordered by referring physicians and physician group practices.

Our PLAC Activity Test sales could be affected by the outcome and the timing of the GlaxoSmithKline’s clinical studies of its Lp-PLA₂ inhibitor, darapladib.

In November 2013, GlaxoSmithKline reported in a press release that their phase 3 trial, named STABILITY, evaluating the Lp-PLA₂ inhibitor, darapladib, did not meet its primary endpoint measure, which was time to first occurrence of any major adverse cardiovascular event (“MACE”). In March 2014, GlaxoSmithKline reported in a press release that the STABILITY trial met two secondary efficacy end points of first time occurrence of major coronary event and total coronary events. In May 2014, GlaxoSmithKline reported in a press release that their second Phase 3 study, named SOLID-TIMI 52, did not meet its primary endpoint measure. These results are expected to limit the adoption and sales of our PLAC Tests that might have been expected had a favorable result been obtained.

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We rely on two manufacturers to supply materials for our PLAC ELISA Test and a limited number of vendors and suppliers to obtain materials for the manufacture of our products. If these manufacturers are unable to deliver our products or these vendors and suppliers are unable to deliver our materials in a timely manner, or at all, we may be unable to meet demand, which would have a material adverse effect on our business.

We have qualified two manufacturers for our PLAC ELISA Test, and we intend to order regularly from both of these third-party manufacturers in the future. We rely on our third-party manufacturers to maintain their manufacturing facility in compliance with FDA and other federal, state and/or local regulations including health, safety and environmental standards. If they fail to maintain compliance with FDA or other critical regulations, they could be ordered to curtail operations, which would have a material adverse impact on our business. In addition, increases in the prices we pay our manufacturer, or lapses in quality, such as failure to meet our specifications or the requirements of the Quality System Regulations (“QSR”) and other regulatory requirements, could materially adversely affect our business. Any manufacturing defect or error discovered after our products have been produced and distributed could result in significant consequences, including costly recall procedures and damage to our reputation. Our ability to replace the existing manufacturers may be difficult, because the number of potential manufacturers is limited.

We also currently depend on certain key vendors and suppliers of materials, some of which are sole source or for whom an alternative could be difficult to replace in a timely manner, that are essential for the manufacture of our products. Any interruption in the supply of materials, or the inability to obtain materials from alternate sources in a timely manner, could impair our ability to supply our products and to meet the demands of our customers, which would have a material adverse effect on our business.

We manufacture our PLAC Activity Test on-site in South San Francisco, California and we could experience process, quality control and shipping problems due to the early stage of manufacturing.

We have been manufacturing our PLAC Activity Test in-house since January 2012. We are dependent on the expertise of our personnel for this product. We could observe performance deviations that have not been apparent during development, including performance and stability of the PLAC Activity Test. The discovery of such performance deviations or of any manufacturing problems may adversely affect our sales in Europe and, if we obtain FDA clearance of our 510(k) application, the US.

We are currently assessing a third party manufacturer for our PLAC Activity Test and our inability to identify such manufacturer may have a material adverse effect on the supply of our product.

If third-party payors do not reimburse our customers for the use of our clinical diagnostic products or if they reduce reimbursement levels, our ability to sell our products could be harmed.

We sell our products primarily through distributors and to laboratory customers, substantially all of which receive reimbursement for the health care services they provide to their patients from third-party payors, such as Medicare, Medicaid and other government programs, private insurance plans and managed care programs. Third-party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement for medical products and services. Accordingly, third-party payors are increasingly challenging the prices charged for diagnostic tests. Most of these third-party payors may deny coverage and reimbursement if they determine that a product was not medically necessary or not used in accordance with cost-effective treatment methods, or was used for an unapproved indication.

In the US, third-party payors generally require billing codes on claims for reimbursement that describe the services provided. For laboratory services, the American Medical Association (“AMA”) establishes most of the billing codes using Current Procedural Terminology (“CPT”) codes. Each third-party payor generally develops payment amounts and coverage policies for their beneficiaries or members that ties to the CPT code established for the laboratory test and, therefore, coverage and reimbursement may differ by payor even if the same billing code is reported for claims filing purposes. For laboratory tests without a specific billing code, payors often review claims on a claim-by-claim basis and there are increased uncertainties as to coverage and eligibility for reimbursement. Currently, the tests performed by our assays are described by existing CPT codes, but we cannot guarantee that the CPT codes will not be revised or that new CPT codes will not be established for these or future assays. If our customers are not reimbursed for our products, they may reduce or discontinue purchases of our products, which would cause our revenues to decline. Lower-than-expected, or decreases in, reimbursement amounts for tests performed using our products may decrease amounts physicians and other practitioners are able to charge patients, which in turn may adversely affect the willingness of physicians and other practitioners to purchase our products at prices we target, or at all. If we are unable to sell our products at target prices, our revenues and gross margins will suffer and our business could be materially harmed.

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Our business, in particular the growth of our business, is dependent on our ability to successfully develop and commercialize novel diagnostic products and services based on biomarkers. If we fail to develop and commercialize or enter into collaborations for new diagnostic products, we may be unable to execute our business plan.

Our long-term ability to generate product revenue will depend in part on our ability to develop additional formats or versions of the PLAC Tests and other new diagnostic products. If internal efforts do not generate sufficient product candidates, we will need to identify third parties that wish to collaborate with us to develop new products and applications. Our ability to enter into third-party relationships will depend in part on our ability to negotiate acceptable license and related agreements. Even if we are successful in establishing collaborative arrangements, they may never result in the successful development or commercialization of any product candidate or the generation of any sales or royalty revenues. In addition, rapid technological developments and innovations characterize the markets for our products and services. Our success will depend in large part on our ability to correctly identify emerging trends, enhance capabilities, and develop and manufacture new products quickly, in a cost-effective manner, and at competitive prices. The development of new and enhanced products is a complex and costly process. We may need to make substantial capital expenditures and incur significant research and development costs to develop and introduce such new products and enhancements. If we fail to timely develop and introduce competitive new products or additional formats of our existing products, our business could be materially adversely affected.

In March 2014, we entered into an exclusive licensing and supply agreement with B.R.A.H.M.S. GmbH to develop and commercialize three independent biomarkers to aid in risk prediction and prognosis for heart failure. In the event we fail to meet certain diligence requirements under the license, our exclusive right for these products will be lost, which may have an adverse effect on our product pipeline and sales.

International expansion of our business exposes us to significant risks associated with doing business outside of the United States.

Our business strategy incorporates international expansion, including establishing and maintaining direct sales and physician outreach and education capabilities outside of the US and expanding our relationship with distributors. We currently market both of our PLAC Tests in Europe. Doing business internationally involves a number of risks, including:

Any of these factors could significantly harm our future international expansion and operations and, consequently, our revenues and results of operations.

Our dependence on distributors for international sales of our PLAC Activity Test could limit or hinder us from selling our tests in Europe and from realizing long-term international revenue growth.

As of September 30, 2014, we had exclusive distribution agreements for our products in 24 countries, mostly in Europe, and we may enter into other similar arrangements in other countries in the future. Exclusive distribution arrangements limit our ability to directly, or indirectly through other distributors, address customers in those countries. Distributors may not commit the necessary resources to market and sell our PLAC Tests to the level of our expectations. We intend to grow our business internationally, and to do so we may need to attract additional distributors to expand the territories in which we sell our PLAC Activity Tests. If current or future distributors do not perform adequately, or we are unable to locate distributors in particular geographic areas, we may not realize long-term international revenue growth.

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The requirements of being a public company have required and will continue to require significant resources, increase our costs and occupy our management, and we may be unable to comply with these requirements in a timely or cost-effective manner.

As a company with public reporting responsibilities, we have incurred and will continue to incur significant legal, accounting, and other expenses related to, among other things:

We will also be subject to additional reporting and compliance requirements if our securities are listed on a national securities exchange or if we cease to be a smaller reporting company under applicable SEC regulations. Compliance with these rules and regulations has and will cause us to incur significant legal and financial compliance costs. In addition, we are required to implement and maintain effective internal control over financial reporting and disclosure. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting. Our testing may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. We have incurred and expect to continue to incur significant expense and devote substantial management effort toward ensuring compliance with these requirements. Moreover, if we are not able to comply with these requirements in a timely manner, or if we identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our common stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.

Natural disasters, including earthquakes, may damage our facilities.

Our corporate, research and manufacturing facilities are located in the San Francisco Bay Area of California, in close proximity to known earthquake fault zones. As a result, these facilities and any clinical samples kept in these facilities are susceptible to damage from earthquakes and other natural disasters, such as fires, floods and similar events. Although we maintain general business insurance against fires and some general business interruptions, there can be no assurance that the scope or amount of coverage will be adequate in any particular case. Insurance specifically for earthquake risks is not available on commercially reasonable terms.

Failure in our information technology and storage systems could significantly disrupt the operation of our business.

Our ability to execute our business plan depends, in part, on the continued and uninterrupted performance of our information technology (“IT”) systems. IT systems are vulnerable to damage from a variety of sources, including telecommunications or network failures, malicious human acts and natural disasters. Moreover, despite network security and back-up measures, some of our servers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems. Despite the precautionary measures we have taken to prevent unanticipated problems that could affect our IT systems, sustained or repeated system failures that interrupt our ability to generate and maintain data could adversely affect our ability to operate our business.

Risks Relating to Government Regulations

We are subject to extensive regulation by the FDA and other regulatory agencies, and failure to comply with such regulation could have a material adverse effect on our business, financial condition, and results of operations.

Our business and our medical device products, including our PLAC Tests, are subject to extensive regulation by the FDA and other federal, state, and foreign regulatory agencies. These laws and regulations govern many aspects of our products and operations, and the products and operations of our suppliers and distributors, including premarket clearance and approval, design, development and manufacturing, labeling, packaging, safety and adverse event reporting, recalls, storage, advertising, promotion, sales and record keeping. Failure to comply with these laws and regulations could result in, among other things, warning letters, civil or criminal penalties, injunctions, delays in clearance or approval of our products, withdrawal of cleared products, recalls, and other operating restrictions, all of which could cause us to incur significant expenses.

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Before we can market or sell a new product or a significant modification to an existing product in the US, we must obtain either clearance under Section 510(k) of the FDCA, or approval of a pre-market approval application (“PMA”), from the FDA, unless an exemption applies. In the 510(k) clearance process, the applicant must demonstrate to the FDA’s satisfaction that a proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to obtain clearance from the FDA to market the proposed device. Clinical data is sometimes required to support substantial equivalence. The PMA pathway requires an applicant to demonstrate the safety and effectiveness of the device based, in part, on extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing, and labeling data. The FDA can delay, limit, or deny clearance or approval of a device for many reasons, including:

Further, any modification we make to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design, or manufacture, would require us to seek a new 510(k) clearance or, possibly, approval of a PMA. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review any manufacturer’s decision. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary for changes to 510(k) cleared devices. If the FDA disagrees with our determination and requires us to submit new 510(k) notifications or PMAs for modifications to our previously cleared products for which we have concluded that new clearances or approvals are unnecessary, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties.

Even when a product reaches the market, the subsequent discovery of previously unknown problems, such as material deficiencies or defects in design, labeling, or manufacture, or a potential unacceptable risk to health, with a product may result in restrictions on the product, including recall or withdrawal of the product from the market, and/or a requirement to submit a new 510(k) submission or PMA for the product in order to support continued marketing.

We and our suppliers are subject to inspections by the FDA and other regulatory agencies, and deficiencies identified during these audits could have a material adverse effect on our results of operations.

Once regulatory clearance or approval has been granted, the product and its manufacturer are subject to continual review by the FDA and other regulatory authorities. For example, we are subject to routine inspection by the FDA and certain state agencies for compliance with the QSR, which establishes the good manufacturing practices for medical devices, and Medical Device Reporting regulations, which require us to report to the FDA any incident in which one of our products may have caused or contributed to a death or serious injury or malfunctioned in a way that could cause death or serious injury. Although we believe that we have adequate processes in place to ensure compliance with these and other post-market requirements, the FDA or other regulatory bodies could disagree and take enforcement action, including issuing warning letters, untitled letters, fines, injunctions, consent decrees or civil penalties, or imposing operating restrictions or partial suspension or total shutdown of manufacturing, selling or exporting our products, among other sanctions, if it concludes that we are out of compliance with applicable regulations or if it concludes that our products pose an unacceptable risk to health or are otherwise deficient in design, labeling or manufacture. Further, the ability of our suppliers to supply critical components or materials and of our distributors to sell our products could be adversely affected if their operations are determined to be out of compliance. The FDA and other regulatory bodies could also require us to recall products if we fail to comply with applicable regulations. Such actions by the FDA and other regulatory bodies would adversely affect our revenues and results of operations.

We are and will be subject to new regulations, which could have a material adverse effect on our results of operations.

Many national, regional, and local laws and regulations, including the recently enacted healthcare reform legislation, have not been fully implemented by the regulatory authorities or adjudicated by the courts, and these provisions are open to a variety of interpretations. In the ordinary course of business, we must frequently make judgments with respect to compliance with applicable laws and regulations. If regulators subsequently disagree with the manner in which we have sought to comply with these regulations, we could be subjected to various sanctions, including substantial civil and criminal penalties, as well as product recall, seizure or injunction with respect to the sale of our products. Such sanctions could severely impair our reputation within the industry and any limitation on our ability to manufacture and market our products could have a material adverse effect on our business. In addition, in January 2011, the FDA announced twenty-five action items it intends to take in reforming the 510(k) premarket review program. The FDA issued its recommendations and proposed action items in response to concerns from both within and outside of the FDA about the 510(k) program. Although the FDA has not detailed the specific modifications or clarifications that the FDA intends to make to its

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guidance, policies, and regulations pertaining to the review and regulation of devices such as ours which seek and receive marketing clearance through the 510(k) process, the FDA’s announced action items signal that additional regulatory requirements are likely. The FDA intends to issue a variety of draft guidance and regulations which, when fully implemented, could impose additional regulatory requirements upon us, which could delay our ability to obtain new clearances, increase the cost of compliance, or restrict our ability to maintain our current 510(k) clearances.

Healthcare reform and its restrictions on coverage and reimbursement may adversely affect our business.

Legislation both proposed and passed has had an impact on reimbursement levels for diagnostic services, including laboratory tests. For instance, in March 2010, President Barack Obama signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively, the “PPACA”), which makes a number of substantial changes to the way health care is financed by both governmental and private insurers. Among other things, the PPACA mandates a reduction in payments for clinical laboratory services paid under the Medicare Clinical Laboratory Fee Schedule of 1.75% for the years 2011 through 2015. A productivity adjustment also is made to the fee schedule payment amount. In addition, on February 22, 2012, President Obama signed the Middle Class Tax Relief and Job Creation Act of 2012, which, among other things, mandated an additional change in Medicare reimbursement for clinical laboratory services. This legislation requires a rebasing of the Medicare clinical laboratory fee schedule to effect a 2% reduction in payment rates otherwise determined for 2013, which in turn will serve as a base for 2014 and subsequent years. Further, with respect to the PPACA changes, the legislation establishes an Independent Payment Advisory Board (“IPAB”) to reduce the per capita rate of growth in Medicare spending. The IPAB has broad discretion to propose policies, which may have a negative impact on payment rates for services, including clinical laboratory services, beginning in 2016, and for hospital services beginning in 2020. In addition, the PPACA provides for an excise tax on medical devices that will potentially increase our costs if we are unable to pass the taxes on to our customers and requires us to disclose all transfers of values to physicians and physician teaching institutions under the sunshine provisions of the PPACA. A failure to properly disclose such transfers could cause Medicare to impose penalties, including substantial financial sanctions.

In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. For example, on August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend proposals in spending reductions to Congress. The Joint Select Committee did not achieve the targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, thereby triggering the legislation’s automatic reduction to several government programs. These automatic budget triggers have been commonly referred to as the sequestration process.

The full impact on our business of the PPACA and the potential impact of the sequestration process is uncertain. Levels of reimbursement may decrease in the future, and future legislation, regulation or reimbursement policies of third-party payors may adversely affect the demand for and price levels of our products.

In April 2014, the President signed the Protecting Access to Medicare Act of 2014 (“PAMA”), which included a substantial new payment system for clinical laboratory tests under the Clinical Laboratory Fee Schedule.  Under PAMA, Medicare payment rates for tests will be equal to the volume-weighted median of the private payor payment rates for a test. The payment rates calculated under PAMA will be effective starting January 1, 2017, and will be reviewed every three years, based on private payor payment rates and volumes for their tests.  We believe that, starting in 2017 and over time, our customers could see decreased reimbursement from Medicare for running our PLAC Tests which may impact the price at which we sell them our kits and negatively impact our revenue growth.

In June 2014, the Office of the Inspector General, (“OIG”) issued a Special Fraud Alert involving compensation paid by laboratories to referring physicians and physician practice groups for blood specimen collection, processing and packaging, and for submitting patient data to a registry or database.  We are unaware of the extent to which our customers have been utilizing the types of business practice, but believe that these OIG guidelines will directly affect our primary customers. At the present time, we cannot predict the responses by our customers to the OIG’s focus on the practices identified in the anti-fraud alerts, but it may have a negative impact on future customer sales and orders.

We are subject to healthcare laws, regulation and enforcement, and our failure to comply with those laws could have a material adverse effect on our results of operations and financial condition.

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

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If our operations are found to be in violation of any of the laws described above or any other governmental laws or regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, the curtailment or restructuring of our operations, the exclusion from participation in federal and state healthcare programs, or imprisonment, any of which could adversely affect our ability to operate our business and our financial results.

Risks Relating to Liquidity

Our Oxford Bank loan contains restrictions that limit our flexibility in operating our business, and our lender may accelerate repayment of amounts outstanding under certain circumstances.

In September 2014, we entered into a Loan and Security Agreement with Oxford Finance LLC (the “Loan and Security Agreement”). The Loan and Security Agreement contains a number of affirmative and restrictive covenants. These covenants limit our ability to, among other things:

If we breach any of these covenants, are unable to make a required payment of principal or interest, or experience a material adverse change to our business, it could result in an event of default under the Loan and Security Agreement. Upon the occurrence of an event of default under the Loan and Security Agreement, Oxford could elect to declare all amounts outstanding to be immediately due and payable. If we were unable to repay the amounts due under the Loan and Security Agreement, Oxford could proceed against the collateral granted to it to secure such indebtedness. We have pledged substantially all of our assets, other than our intellectual property, as collateral under the loan.

We will need to raise additional capital to support our operations in the future.

We will require additional funds to commercialize our products and develop new products. Our ability to fund our operations and to conduct the required development activities related to any new product candidates will be significantly limited if we are unable to obtain the necessary capital. We will seek to raise funds through equity or debt offerings, bank facilities, or other sources of capital. Additional funding may not be available when needed or on terms acceptable to us. The consent of Oxford Finance LLC will likely be required for additional debt financings. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. We cannot assure you that we will be able to raise any such additional funding.

We are an early stage company with a history of losses, we expect to incur losses for at least the next few years, and we may never achieve profitability.

We have incurred substantial net losses since our inception. Our accumulated deficit was $206.1 million at September 30, 2014. For the nine months ended September 30, 2014 and 2013, we incurred net losses of $6.2 million and $2.0 million, respectively. We expect to continue to incur net losses for at least the next few years based on our current plans to engage in new development activities to broaden or enhance our product pipeline. If we are unable to execute our commercialization strategy to achieve profitability, or if the time required to achieve profitability is longer than we anticipate, we may not be able to continue our business.

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Moreover, we are solely dependent on our product line of PLAC Tests. We expect that the PLAC Tests will account for a substantial portion of our revenue for the foreseeable future. We do not know if our PLAC Tests will be successful over the long-term and it is possible that the demand for the product may decline over time, and any quarter or other period of profitability may not be sustainable without continued growth in sales of our PLAC Tests. We may never be able to commercialize the PLAC Activity Test in the US. Any decline in demand or failure of our PLAC Tests to penetrate current or new markets significantly could have a material adverse effect on our business, financial condition, and results of operations. Moreover, the sale of PLAC Tests may not continue to grow at the historical rates that we have experienced in the past, and any reduction in demand from one or more of our major customers would have a significant impact on our ability to achieve and maintain profitability.

We have liabilities for real estate leases in excess of what is necessary for our current business. We will incur these additional expenses until we are able to sublease a portion of our larger leased facility.

We have a significant real estate lease for a facility of approximately 65,000 square feet with current monthly minimum required expenses of approximately $220,000. The term of the lease continues until December 31, 2016. Until such time that we are able to sublease a portion of the facility, we will incur liabilities for real estate leases significantly in excess of what is necessary for our current business. We may never be able to sublease a portion of the facility.

Risks Relating to Intellectual Property

If the combination of patents, trade secrets, trademarks, and contractual provisions that we rely on to protect our intellectual property proves inadequate, our ability to successfully commercialize our products will be harmed and we may never be able to operate our business profitably.

Our success depends, in large part, on our ability to protect proprietary discoveries, technology, brands, creative works, and diagnostic tests under the patent and other intellectual property laws of the US and other countries, so that we can seek to prevent others from unlawfully using our proprietary inventions and information. We hold issued patents in the US covering our PLAC ELISA Test, the last of which expires in December 2015.

Additionally, we have filed or have licensed rights to a number of patent applications that are in an early stage of prosecution, and we cannot make any assurances that any of the pending patent applications will become issued and enforceable patents. In addition, due to technological changes that may affect our proposed products or judicial interpretation of the scope of our patents, our proposed products might not, now or in the future, be adequately covered by our patents.

Moreover, the US Leahy-Smith America Invents Act, with central provisions effective as of March 2013, brings significant changes to the US patent system, which include a change to a “first to file” system from a “first to invent” system and changes to the procedures for challenging issued patents and disputing patent applications during the examination process, among other things. The effects of these changes on our patent portfolio and business have yet to be determined, as the US Patent and Trademark Office is implementing regulations relating to these changes and US courts have yet to address the new provisions. However, these changes could increase the costs and uncertainties surrounding the prosecution of our patent applications and the enforcement or defense of our patent rights.

Furthermore, recently issued US Supreme Court decisions in cases involving patents claiming genetic materials and information, and diagnostic products and methods based on genetic materials and information may impact our business. For example, on March 20, 2012, in Mayo Collaborative Services, DBA Mayo Medical Laboratories, et al. v. Prometheus Laboratories, Inc., the US Supreme Court issued an opinion holding that the processes claimed by Prometheus’ patent were not patent eligible because these processes—determining the relationships between concentrations of certain metabolites in the blood and the likelihood that a thiopurine drug dosage will prove ineffective or cause harm—merely apply laws of nature and are not themselves patentable. On June 13, 2013 in Association for Molecular Pathology et al.v. Myriad Genetics, Inc., et al. the US Supreme Court issued an opinion holding that a naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated, but cDNA is patent eligible because it is not naturally occurring. It is unknown what impact these decisions will have with respect to our patents.

We license key intellectual property from GlaxoSmithKline and ICOS, and our contractual relationships have certain limitations.

We have an exclusive license from GlaxoSmithKline (formerly SmithKlineBeecham plc) and a co-exclusive license from ICOS Corporation (“ICOS”), subsequently acquired by Eli Lilly and Company, to practice and commercialize technology covered by several issued and pending US patents and their foreign counterparts. Some of these licensed patents covering composition of matter and cardiovascular diagnostic claims have different expiration dates from 2014 through 2016, which may limit our ability to generate future revenue from products claimed under those exclusive and co-exclusive licenses. While we have a family of issued patents and pending applications directed to the measurement of Lp-PLA₂ activity in the presence of an inhibitor of Lp-PLA₂ activity has expiration date ranging from 2025 to 2026. There can be no assurance that those patent applications will be issued or that any issued patents will maintain a competitive advantage for our Lp-PLA₂ products.

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Several of our agreements with each of GlaxoSmithKline and ICOS provide licenses to use intellectual property that is important to our business, and we may enter into additional agreements in the future with GlaxoSmithKline or with other third parties that change licenses to valuable technology. Current licenses impose, and future licenses may impose, various commercialization, milestone and other obligations on us, including the obligation to terminate our use of patented subject matter under certain circumstances. If a licensor becomes entitled to, and exercises, termination rights under a license, we could lose valuable rights and our ability to develop our current and future products. Our business may suffer if any current or future licenses terminate, if the licensors fail to abide by the terms of the license or fail to prevent infringement by third parties, if the licensed patents or other rights are found to be invalid or if we are unable to enter into necessary licenses on acceptable terms.

Any inability to adequately protect our proprietary technologies and product candidates could harm our competitive position.

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. We plan to continue to apply for patents covering our technologies and products as we deem appropriate. We cannot make assurances that our pending patent applications will issue as patents and, if they do, whether the scope of such claims will be sufficiently broad to prevent third parties from utilizing our technologies, commercializing our discoveries, or developing competing products. Any patents we currently hold, or obtain in the future, may be held invalid or unenforceable or may not be sufficiently broad to prevent others from utilizing our technologies, commercializing our discoveries, or developing competing technologies and products. Moreover, expiration or invalidation of our issued patents may impact our ability to maintain the competitive position of our products. Furthermore, third parties may independently develop similar or alternative technologies or design around our patented technologies. Third parties may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantage.

We have rights to patents and patent applications owned by licensors that provide important protection on the composition of matter and utility of our products, product candidates and product pipeline. We do not, however, directly control the prosecution and maintenance of all of these patents. A licensor may not fulfill its obligations under a license and may allow these patents to go abandoned or may not pursue meaningful claims for our products. Also, while the US Patent and Trademark Office has issued patents covering diagnostic utility or methods, we do not know whether or how courts will enforce these patents. If a court finds our patents for these types of inventions to be invalid, unenforceable or interprets them narrowly, the benefits of our patent strategy may not materialize. If any or all of these events occur, they could diminish the value of our intellectual property.

Risks Relating to Our Stock

Our stock price is likely to continue to be volatile.

Currently, our common stock is quoted on the OTC Bulletin Board. Stocks traded “over the counter” typically are subject to greater volatility than stocks traded on stock exchanges, such as the NASDAQ Stock Market, due to the fact that OTC trading volumes are generally significantly lower than those on stock exchanges. This lower volume may allow a relatively few number of stock trades to greatly affect the stock price, particularly where the trading price of the stock price is relatively low. The trading price of our common stock has been and is likely to continue to be extremely volatile. Some of the many factors that may cause the market price of our common stock to fluctuate include, in no particular order:

The stock markets and the markets for medical diagnostics and biotechnology stocks in particular, have experienced volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. Investors may not be able to sell when they desire due to insufficient buyer demand and may realize less than, or lose all of, their investment.

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We are not currently listed on a national exchange and there can be no assurance we will ever be listed.

As a result of our failure to make timely filings of financial statements, we were delisted from The NASDAQ Stock Market in 2004. Currently, our common stock is quoted on the OTC Bulletin Board under the symbol DDXS. We do not know when, if ever, our common stock will be listed on a national stock exchange. In order to be eligible for relisting or listing, we must meet the initial listing criteria for The NASDAQ Stock Market or another national exchange, including a minimum per share price. We cannot assure you that we will be able to satisfy these requirements, or if we satisfy them, that we will be able to maintain compliance with them.

Our charter documents and Delaware law may discourage an acquisition of our Company.

Provisions of our certificate of incorporation, bylaws, and Delaware law could make it more difficult for a third-party to acquire us, even if doing so would be beneficial to our stockholders. For example, we may issue shares of preferred stock in the future without stockholder approval and upon such terms as our Board of Directors may determine. Our issuance of this preferred stock could have the effect of making it more difficult for a third-party to acquire, or of discouraging a third-party from acquiring, a majority of our outstanding stock. Our bylaws also provide that special stockholder meetings may be called only by our Board of Directors, Chairperson of the Board of Directors, or by our Chief Executive Officer or President, with the result that any third-party takeover not supported by the Board of Directors could be subject to significant delays and difficulties.

 

None.

 

None

 

Not applicable

 

None

 

 

 

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* Certain portions of this document have been omitted pursuant to a confidential treatment request. The omitted information has been filed separately with the SEC.

 

 

 

 

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SIGNATURES

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

 

 

 

 

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EXHIBIT INDEX

 

 

* Certain portions of this document have been omitted pursuant to a confidential treatment request. The omitted information has been filed separately with the SEC.

 

 

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