Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - CANCER GENETICS, INCFinancial_Report.xls
EX-32.2 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit322certifica.htm
EX-32.1 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit321certifica.htm
EX-10.5 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit105securitya.htm
EX-10.6 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit106firstamen.htm
EX-10.4 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit104equitydyn.htm
EX-31.1 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit311certifica.htm
EX-31.2 - EXHIBIT - CANCER GENETICS, INCa2014q3exhibit312certifica.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
 
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-35817
 
CANCER GENETICS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
04-3462475
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
201 Route 17 North 2nd Floor
Rutherford, NJ 07070
(201) 528-9200
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

1


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.
 
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
As of November 1, 2014, there were 9,723,669 shares of common stock, par value $0.0001 of Cancer Genetics, Inc. outstanding.
 

2


CANCER GENETICS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 


3


PART I — FINANCIAL INFORMATION 
Item 1.    Financial Statements (Unaudited)
Cancer Genetics, Inc. and Subsidiaries
Consolidated Balance Sheets (Unaudited)
 
September 30,
2014
 
December 31,
2013
ASSETS
 
 
 
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
30,748,275

 
$
49,459,564

Accounts receivable, net of allowance for doubtful accounts
4,108,567

 
1,567,039

Other current assets
1,161,537

 
864,616

Total current assets
36,018,379

 
51,891,219

FIXED ASSETS, net of accumulated depreciation
4,338,146

 
1,264,624

OTHER ASSETS
 
 
 
Security deposits
1,564

 
1,564

Restricted cash
6,300,000

 
300,000

Loan guarantee and financing fees, net of accumulated amortization of $517,500 in 2013

 
310,500

Patents
476,971

 
401,709

Investment in joint venture
1,328,231

 
987,657

Other investments
39,393

 

Goodwill
3,130,574

 

Total other assets
11,276,733

 
2,001,430

Total Assets
$
51,633,258

 
$
55,157,273

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES
 
 
 
Accounts payable and accrued expenses
$
4,564,065

 
$
2,346,240

Obligations under capital leases, current portion
57,606

 
51,400

Deferred revenue
384,354

 
199,560

Notes payable, current portion
280,854

 
22,298

Line of credit

 
6,000,000

Total current liabilities
5,286,879

 
8,619,498

Obligations under capital leases
322,939

 
309,777

Deferred rent payable
152,739

 
170,789

Line of credit
6,000,000

 

Warrant liability
145,000

 
594,000

Other long-term liabilities
767,663

 

Deferred revenue, long-term
936,496

 

Total liabilities
13,611,716

 
9,694,064

STOCKHOLDERS’ EQUITY
 
 
 
Preferred stock, authorized 9,764,000 shares, $0.0001 par value, none issued

 

Common stock, authorized 100,000,000 shares, $0.0001 par value, 9,723,669 and 9,275,384 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
970

 
927

Additional paid-in capital
110,814,811

 
106,786,862

Accumulated deficit
(72,794,239
)
 
(61,324,580
)
Total Stockholders’ Equity
38,021,542

 
45,463,209

Total Liabilities and Stockholders’ Equity
$
51,633,258

 
$
55,157,273

See Notes to Unaudited Consolidated Financial Statements.

4


Cancer Genetics, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited) 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
3,221,850

 
$
1,705,146

 
$
6,163,895

 
$
4,755,462

Cost of revenues
2,565,715

 
1,211,384

 
5,358,872

 
3,560,678

Gross profit
656,135

 
493,762

 
805,023

 
1,194,784

Operating expenses:
 
 
 
 

 

Research and development
1,390,189

 
433,525

 
3,092,733

 
1,384,122

General and administrative
3,104,100

 
1,297,801

 
8,230,966

 
4,259,175

Sales and marketing
1,070,531

 
442,665

 
2,737,967

 
1,274,620

Total operating expenses
5,564,820

 
2,173,991

 
14,061,666

 
6,917,917

Loss from operations
(4,908,685
)
 
(1,680,229
)
 
(13,256,643
)
 
(5,723,133
)
Other income (expense):
 
 
 
 

 

Interest expense
(36,166
)
 
(356,442
)
 
(408,087
)
 
(2,039,750
)
Interest income
18,789

 
3,295

 
57,130

 
4,649

Debt conversion costs

 

 

 
(6,849,830
)
Change in fair value of warrant liability
129,000

 
(1,033,000
)
 
324,000

 
4,096,000

Total other income (expense)
111,623

 
(1,386,147
)
 
(26,957
)
 
(4,788,931
)
Income (loss) before income taxes
(4,797,062
)
 
(3,066,376
)
 
(13,283,600
)
 
(10,512,064
)
Income tax provision (benefit)

 

 
(1,813,941
)
 
(663,900
)
Net (loss)
$
(4,797,062
)
 
$
(3,066,376
)
 
$
(11,469,659
)
 
$
(9,848,164
)
Basic net (loss) per share
$
(0.50
)
 
$
(0.61
)
 
$
(1.22
)
 
$
(2.84
)
Diluted net loss per share
$
(0.51
)
 
$
(0.61
)
 
$
(1.25
)
 
$
(4.02
)
Basic Weighted Average Shares Outstanding
9,575,789

 
5,055,591

 
9,386,613

 
3,463,730

Diluted Weighted Average Shares Outstanding
9,575,789

 
5,055,591

 
9,403,245

 
3,468,627

See Notes to Unaudited Consolidated Financial Statements.

5


Cancer Genetics, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited) 
 
Nine Months Ended September 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES

 

Net (loss)
$
(11,469,659
)
 
$
(9,848,164
)
Adjustments to reconcile net (loss) to net cash used in operating activities:

 

Depreciation
487,656

 
227,376

Amortization
20,146

 
11,422

Equity-based consulting and compensation expenses
2,129,880

 
310,982

Equity-based research and development expenses

 
96,220

Change in fair value of warrant liability
(324,000
)
 
(4,096,000
)
Amortization of loan guarantee and financing fees
310,500

 
884,460

Accretion of discount on debt

 
584,692

Deferred rent
(18,050
)
 
4,868

Loss in equity method investment
659,426

 

Deferred initial public offering costs expensed

 
617,706

Write-off of debt conversion costs

 
6,849,830

Change in working capital components:

 

Accounts receivable
(521,429
)
 
(765,589
)
Other current assets
(169,940
)
 
(223,849
)
Accounts payable, accrued expenses and deferred revenue
985,644

 
(1,255,166
)
Net cash (used in) operating activities
(7,909,826
)
 
(6,601,212
)
CASH FLOWS FROM INVESTING ACTIVITIES

 

Purchase of fixed assets
(944,423
)
 
(72,840
)
Increase in restricted cash
(6,000,000
)
 
(50,000
)
Patent costs
(95,408
)
 
(52,771
)
Investment in JV
(1,000,000
)
 

Cash used in acquisition of Gentris, net of cash received
(3,180,930
)
 

Cash from acquisition of BioServe
311,264

 

Net cash (used in) investing activities
(10,909,497
)
 
(175,611
)
CASH FLOWS FROM FINANCING ACTIVITIES

 

Principal payments on capital lease obligations
(21,554
)
 
(12,762
)
Proceeds from initial public offering of common stock, net of offering costs

 
4,984,025

Proceeds from secondary public offering of common stock, net of offering costs

 
14,230,372

Proceeds from warrant exercises
178,102

 
192,000

Proceeds from option exercises
79,018

 

Principal payments on notes payable
(127,532
)
 
(3,558,542
)
Net cash provided by financing activities
108,034

 
15,835,093

Net (decrease) increase in cash and cash equivalents
(18,711,289
)
 
9,058,270

CASH AND CASH EQUIVALENTS

 

Beginning
49,459,564

 
819,906

Ending
$
30,748,275

 
$
9,878,176

SUPPLEMENTAL CASH FLOW DISCLOSURE

 

Cash paid for interest
$
92,692

 
$
570,601

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES

 

Warrants issued for financing fees
$

 
$
47,000

Accrued offering costs

 

Fixed assets acquired through capital lease arrangements
40,922

 

Cashless exercise of derivative warrants
125,000

 
373,000

Offering costs discounted

 
733,250

Accrued expenses reclassified as derivative warrant liability

 
221,000

Retirement of treasury stock

 
17,442


6


Conversion of notes payable, lines of credit and accrued interest to common stock

 
9,364,300

Value of shares issued as partial consideration to purchase Gentris and BioServe
1,515,992

 

Conversion of preferred stock to common stock

 
241

Reclassification of derivative warrants

 
7,170,000

Reclassification of deferred offering costs to additional paid in capital

 
1,992,333

Net tangible assets acquired via acquisition
1,255,084

 

See Notes to Unaudited Consolidated Financial Statements.

7


Notes to Unaudited Consolidated Financial Statements

Note 1.     Description of Business, Acquisitions, Public Offerings and Reverse Stock Splits

We are an emerging leader in the field of genomic-based cancer diagnostics. The products and services we are developing are poised to transform cancer patient management, increase treatment efficacy, and reduce healthcare costs. We target cancers where prognosis information is critical and where predicting treatment outcomes using currently available techniques is limited. These cancers include hematological, urogenital and HPV-associated cancers. We seek to provide our tests and services to oncologists and pathologists at hospitals, cancer centers and physician offices, as well as to biopharmaceutical companies and clinical research organizations for their clinical trials.

Our services are performed at our state-of-the-art laboratories located in New Jersey, North Carolina, Shanghai (China), and Hyderabad, India. Our laboratories comply with the highest regulatory standards as appropriate for the services they deliver including CLIA, CAP, NY State and NABL (India). Our scientific and clinical advisory boards include leading specialists in clinical oncology, as well as industry thought leaders working to drive adoption of our unique tests and services globally.  Our services are built on a foundation of world-class scientific knowledge and intellectual property in solid and blood-borne cancers, as well as strong academic relationships with major cancer centers such as Memorial Sloan-Kettering, Mayo Clinic, and the National Cancer Institute.

Acquisition - Gentris Corporation

On July 16, 2014, we purchased substantially all of the assets of Gentris Corporation, a Delaware corporation (“Gentris”), with its principal place of business in North Carolina. Gentris provides genomic testing and pharmacogenomics services to half of the top ten biopharma companies globally and has participated and performed genomic analysis for over 1,000 clinical trials. Gentris has operations in Raleigh (Research Triangle Park), North Carolina and Shanghai, China. The acquisition allows the company to expand biopharma services to new customers.

The assets and liabilities of Gentris were recorded in the Company's consolidated financial statements at their estimated fair values as of the acquisition date. The excess value of the consideration paid over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Goodwill recorded in conjunction with the acquisition is deductible for income tax purposes.

The total consideration recorded for the Gentris acquisition is as follows:
 
Amount
Cash paid at closing
$
3,250,000

Issuance of 147,843 common shares
1,271,745

Estimated fair value of contingent consideration
283,000

Total Purchase Price
$
4,804,745


We incurred a finder's fee of $147,500 related to the transaction.

The transaction is being accounted for using the acquisition method of accounting for business combinations in accordance with GAAP. Under this method, the total consideration transferred to consummate the acquisition is being allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values as of the closing date of the acquisition. The acquisition method of accounting requires extensive use of estimates and judgments to allocate the consideration transferred to the identifiable tangible and intangible assets acquired and liabilities assumed. Accordingly, the allocation of the consideration transferred in the condensed consolidated financial statements is preliminary and will be adjusted upon completion of the final valuation of the assets acquired and liabilities assumed. The final valuation is expected to be completed as soon as practicable but no later than 12 months after the closing date of the acquisition.

The preliminary allocation of the total purchase price to the fair value of the assets acquired and liabilities assumed as of July 16, 2014 are as follows:


8


 
Amount
Accounts receivable
$
1,869,097

Other current assets
271,085

Fixed assets
1,950,885

Goodwill
2,589,009

Current liabilities
(937,558
)
Deferred revenue, long-term
(937,773
)
Total Purchase Price
$
4,804,745


Acquisition - BioServe India

On August 18, 2014, we entered into two related agreements whereby we acquired BioServe BioTechnologies (India) Private Limited, an Indian corporation (“BioServe”). These transactions were completed through a newly formed subsidiary, Cancer Genetics (India) Pvt. Ltd.

BioServe is a leading genomic service and next-generation sequencing company serving both the research and clinical markets based in Hyderabad, India. With the BioServe acquisition we believe we will be able to access the Indian healthcare market. The acquisition provides us with an infrastructure in India for developing lower cost manufacturing of probes and kits including probes and kits used for our proprietary FHACT test and access to one of the fastest-growing molecular and clinical diagnostic markets in the world. BioServe will continue to serve biotechnology and biopharmaceutical companies, diagnostic companies and research hospitals, including those owned or operated by the Indian government, as well as seek to expand its customer base.

The parties to the first agreement (the “India Agreement”) are the Company, Ramakishna V. Modali (the current general manager of BioServe, “Modali”), Ventureast Trustee Company Pvt Ltd and affiliates, its principal shareholder (“Ventureast”), and certain other shareholders residing in India all of whom in the aggregate owned approximately 74% of BioServe. The parties to the second share purchase agreement (the “US Agreement”) are the Company and BioServe Biotechnologies LTD, a Maryland corporation and an affiliate of BioServe which owned approximately 15% of BioServe, with the majority of the other outstanding shares held by the BioServe Employee Stock Ownership Plan which will remain in place.

The assets and liabilities of BioServe were recorded in the Company's consolidated financial statements at their estimated fair values as of the acquisition date. The excess value of the consideration paid over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Goodwill recorded in conjunction with the acquisition is not deductible for income tax purposes. The aggregate purchase price is as follows:
 
Amount
Cash paid at closing
$
72,907

Notes payable due 12-18 months after closing
23,708

Notes payable (value of 84,278 common shares)
733,387

Issuance of 31,370 common shares
244,247

Total Purchase Price
$
1,074,249


The ultimate payment to VenturEast will be the value of 84,278 shares of our common stock at the time of payment. This payment will be made the earlier of 30 months from the date of the acquisition agreement (November 2016) or the date of a public offering by us of our common stock prior to that time. This liability is subject to future adjustment based upon changes to the company's stock price.

The transaction is being accounted for using the acquisition method of accounting for business combinations in accordance with GAAP. Under this method, the total consideration transferred to consummate the acquisition is being allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values as of the closing date of the acquisition. The acquisition method of accounting requires extensive use of estimates and judgments to allocate the consideration transferred to the identifiable tangible and intangible assets acquired and liabilities assumed. Accordingly, the allocation of the consideration transferred in the condensed consolidated financial statements is preliminary and will be

9


adjusted upon completion of the final valuation of the assets acquired and liabilities assumed. The final valuation is expected to be completed as soon as practicable but no later than 12 months after the closing date of the acquisition.

The preliminary allocation of the total purchase price to the fair value of the assets acquired and liabilities assumed as of August 18, 2014 are as follows:
 
Amount
Accounts receivable
$
151,002

Other current assets
120,528

Fixed assets
624,948

Other assets
416,869

Goodwill
541,565

Current liabilities
(758,614
)
Other liabilities
(22,049
)
Total Purchase Price
$
1,074,249


The following table provides certain pro forma financial information for the Company as if the acquisitions discussed above occurred on January 1, 2013:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
3,493,345

 
$
3,864,163

 
$
10,329,910

 
$
12,198,309

Net loss
(6,039,858
)
 
(3,836,773
)
 
(13,325,068
)
 
(10,634,909
)
 
 
 
 
 
 
 
 
Basic net loss per share
$
(0.63
)
 
$
(0.73
)
 
$
(1.40
)
 
$
(2.92
)
Dilutive net loss per share
(0.64
)
 
(0.73
)
 
(1.43
)
 
(4.04
)

The results of operations for the three and nine months ended September 30, 2014 include the operations of Gentris from July 16, 2014 and BioServe from August 18, 2014 and include combined revenues of $1,384,309 and a combined net loss of $372,544.

Public Offerings and Reverse Stock Splits

In April 2013, we sold shares of our common stock in an initial public offering (“IPO”). Additionally, we sold shares of our common stock in public offerings in August 2013 and in October 2013. Refer to Note 6 for further discussion of these offerings.

On February 8, 2013, we filed a charter amendment with the Secretary of State for the State of Delaware and effected a 1-for-2 reverse stock split of our common stock. On March 1, 2013, we filed another charter amendment with the Secretary of State for the State of Delaware and effected a 1-for-2.5 reverse stock split of our common stock. All shares and per share information referenced throughout the consolidated financial statements reflect both reverse splits.

Note 2.     Significant Accounting Policies

Basis of presentation: The accompanying unaudited condensed financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for interim reporting as prescribed by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2013 that are included in our Form 10-K filed with the SEC on March 28, 2014. The consolidated balance sheet as of December 31, 2013, included herein was derived from the audited financial statements as of

10


that date, but does not include all disclosures including notes required by GAAP. Interim financial results are not necessarily indicative of the results that may be expected for any future interim period or for the year ending December 31, 2014.

Segment Reporting: Operating segments are defined as components of an enterprise about which separate discrete information is used by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. We view our operations and manage our business in one operating segment, which is the business of developing and providing diagnostic tests.

Liquidity: Our primary sources of liquidity have been funds generated from our debt financings and equity financings. In addition, we have generated funds from the following sources: (i) cash collections from our customers (ii) cash received from sales of state net operating loss carryforwards, and; (iii) grants from the National Institutes of Health.

Principles of consolidation: The accompanying consolidated financial statements include the accounts of Cancer Genetics, Inc. and our wholly owned subsidiaries, Cancer Genetics Italia S.r.l (“CGI Italia”), Gentris LLC (from July 16, 2014) and CGI India (BioServe) (from August 18, 2014).

Use of estimates and assumptions: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management include, among others, realization of amounts billed, realization of long-lived assets, realization of intangible assets, accruals for litigation and registration payments and assumptions used to value stock options and warrants. Actual results could differ from those estimates.

Risks and uncertainties: We operate in an industry that is subject to intense competition, government regulation and rapid technological change. Our operations are subject to significant risk and uncertainties including financial, operational, technological, regulatory and other risks, including the potential risk of business failure.

Cash and cash equivalents: Highly liquid investments with original maturities of three months or less when purchased are considered to be cash equivalents. Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents. We maintain cash and cash equivalents with high-credit quality financial institutions. At times, such amounts may exceed insured limits. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk on our cash and cash equivalents.

Restricted cash: Represents cash held at financial institutions which we may not withdraw and which collateralizes certain of our financial commitments. All of our restricted cash is invested in interest bearing certificates of deposit. Our restricted cash collateralizes a fully-utilized $6.0 million line of credit with Wells Fargo Bank and a $300,000 letter of credit in favor of our landlord, pursuant to the terms of the lease for our Rutherford facility.

Revenue recognition: Revenue is recognized in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition, and ASC 954-605 Health Care Entities, Revenue Recognition which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the customer or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured. In determining whether the price is fixed or determinable, we consider payment limits imposed by insurance carriers and Medicare and the amount of revenue recorded takes into account the historical percentage of revenue we have collected for each type of test for each payor category. Periodically, an adjustment is made to revenue to record differences between our anticipated cash receipts from insurance carriers and Medicare and actual receipts from such payors. For the periods presented, such adjustments were not significant. For biopharmaceutical customers, revenue is recorded based upon the contractually agreed upon fee schedule. When assessing collectability, we consider whether we have sufficient payment history to reliably estimate a payor’s individual payment patterns. For new tests where there is no evidence of payment history at the time the tests are completed, we only recognize revenues once reimbursement experience can be established. Until then, we recognize revenue equal to the amount of cash received. Sales of probes are recorded on the shipping date. We do not bill customers for shipping and handling fees and do not collect any sales or other taxes.

Revenues from grants to support product development are recognized when costs and expenses under the terms of the grant have been incurred and payments under the grants become contractually due.


11


Accounts receivable: Accounts receivable are carried at original invoice amount less an estimate for contractual adjustments and doubtful receivables, the amounts of which are determined by an analysis of individual accounts. Our policy for assessing the collectability of receivables is dependent upon the major payor source of the underlying revenue. For direct bill clients, an assessment of credit worthiness is performed prior to initial engagement and is reassessed periodically. If deemed necessary, an allowance is established on receivables from direct bill clients. For insurance carriers where there is not an established pattern of collection, revenue is not recorded until cash is received. For receivables where insurance carriers have made payments to patients instead of directing payments to the Company, an allowance is established for a portion of such receivables. After reasonable collection efforts are exhausted, amounts deemed to be uncollectible are written off against the allowance for doubtful accounts. Since the Company only recognizes revenue to the extent it expects to collect such amounts, bad debt expense related to receivables from patient service revenue is recorded in general and administrative expense in the consolidated statement of operations. Recoveries of accounts receivable previously written off are recorded when received.

Deferred revenue: Payments received in advance of services rendered are recorded as deferred revenue and are subsequently recognized as revenue in the period in which the services are performed.

Fixed assets: Fixed assets consist of diagnostic equipment, furniture and fixtures and leasehold improvements. Fixed assets are carried at cost and are depreciated over the estimated useful lives of the assets, which generally range from five to seven years. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the improvements. The straight-line method is used for depreciation and amortization. Repairs and maintenance are charged to expense as incurred while improvements are capitalized. Upon sale, retirement or disposal of fixed assets, the accounts are relieved of the cost and the related accumulated depreciation or amortization with any gain or loss recorded to the consolidated statement of operations.

Fixed assets are reviewed for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent in our estimate of future cash flows to determine recoverability of these assets. If our assumptions about these assets were to change as a result of events or circumstances, we may be required to record an impairment loss.

Goodwill: Goodwill resulted from the purchases of Gentris and BioServe in 2014 as described in Note 1. In accordance with ASC 350, Intangibles - Goodwill and Other, we are required to test goodwill for impairment and adjust for impairment losses, if any, at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. No such losses were incurred during the nine months ended September 30, 2014.

Loan guarantee and financing fees: Loan guarantee fees are amortized on a straight-line basis over the term of the guarantee. Financing fees are amortized using the effective interest method over the term of the related debt.

Warrant liability: We have issued certain warrants which contain an exercise price adjustment feature in the event we issue additional equity instruments at a price lower than the exercise price of the warrant. The warrants are described herein as derivative warrants. We account for these derivative warrants as liabilities. These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the binomial lattice valuation pricing model with the assumptions as follows. The risk-free interest rate for periods within the contractual life of the warrant is based on the U.S. Treasury yield curve. The expected life of the warrants is based upon the contractual life of the warrants. Volatility is estimated based on an average of the historical volatilities of the common stock of three entities with characteristics similar to those of the Company. Prior to our IPO, the measurement date fair value of the underlying common shares was based upon an external valuation of our shares. Following the IPO in April 2013 and until our shares listed on the NASDAQ Capital Market in August 2013, we used the closing price of our shares on the OTC Bulletin Board. Following the listing of our shares on the NASDAQ Capital Market in August 2013, we used the closing price on the NASDAQ Capital Market.

We compute the fair value of the warrant liability at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component in the value of the warrant liability is our stock price, which is subject to significant fluctuation and is not under our control. The resulting effect on our net income (loss) is therefore subject to significant fluctuation and will continue to be so until the warrants are exercised, amended or expire. Assuming all other fair value inputs remain constant, we will record non-cash expense when the stock price increases and non-cash income when the stock price decreases.

Income taxes: Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred income taxes. Deferred income taxes are recognized for temporary differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Deferred income taxes are also recognized for net operating loss carryforwards that are available to offset future taxable income and research and development credits.

12



Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We have established a full valuation allowance on our deferred tax assets.

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in the financial statements. ASC 740 provides that a tax benefit from uncertain tax positions may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. ASC 740 also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Our policy is to recognize interest and/or penalties related to income tax matters in income tax expense. There is no accrual for interest or penalties on our consolidated balance sheets and we have not recognized interest and/or penalties in the consolidated statements of operations.
In January 2013, we executed a sale of $8,018,107 of gross State of New Jersey NOL carryforwards, resulting in the receipt of $663,900 . The proceeds were recorded as an income tax benefit in January 2013. In January 2014, we executed a sale of $22,301,643 of gross state NOL carryforwards resulting in the receipt of $1,813,941. The Company transferred the NOL carryforwards through the Technology Business Tax Certificate Transfer Program sponsored by the New Jersey Economic Development Authority.

Patents: We account for intangible assets under ASC 350-30. Patents consist of legal fees incurred and are recorded at cost and amortized over the useful lives of the assets, using the straight-line method. Certain patents are in the legal application process and therefore are not currently being amortized. We review the carrying value of patents at the end of each reporting period. Based upon our review, there were no intangible asset impairments during the periods reported. Accumulated amortization of patents as of September 30, 2014 and December 31, 2013 was approximately $76,000 and $56,000, respectively.

Research and development: Research and development costs associated with service and product development include direct costs of payroll, employee benefits, stock-based compensation and supplies and an allocation of indirect costs including rent, utilities, depreciation and repairs and maintenance. All research and development costs are expensed as they are incurred.

Registration payment arrangements: We account for our obligations under registration payment arrangements in accordance with ASC 825-20, Registration Payment Arrangements. ASC 825-20 requires us to record a liability if we determine a registration payment is probable and if it can reasonably be estimated. As of September 30, 2014 and December 31, 2013, we have an accrued liability of $300,000 related to the issuance of Series B preferred stock.

Stock-based compensation: Stock-based compensation is accounted for in accordance with the provisions of ASC 718, Compensation-Stock Compensation, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. We estimate the fair value of stock-based awards on the date of grant using the Black-Scholes option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. See additional information in Note 7.

All issuances of stock options or other issuances of equity instruments to employees as the consideration for services received by us are accounted for based on the fair value of the equity instrument issued.

We account for stock-based compensation awards to non-employees in accordance with ASC 505-50, Equity Based Payments to Non-Employees. Under ASC 505-50, we determine the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. Stock-based compensation awards issued to non-employees are recorded in expense and additional paid-in capital in stockholders’ equity over the applicable service periods based on the fair value of the awards or consideration received at the vesting date.

Fair value of financial instruments: The carrying amount of cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses, approximate their estimated fair values due to the short term maturities of those financial instruments. These financial instruments are considered Level 1 measurements under the fair value hierarchy. The fair values of our notes payable, line of credit and capital leases approximate carrying value under Level 2 of the fair value hierarchy. The fair value of warrants recorded as derivative liabilities is described in Note 9.


13


Joint venture accounted for under the equity method: The Company records its joint venture investment following the equity method of accounting, reflecting its initial investment in the joint venture and its share of the joint venture’s net earnings or losses and distributions. The Company’s share of the joint venture’s net loss was approximately $349,233 and $0 for the three months ended September 30, 2014 and 2013, respectively and $659,426 and $0 for the nine months ended September 30, 2014 and 2013, respectively, and is included in research and development expense on the Consolidated Statement of Operations. The Company has a net receivable due from the joint venture of approximately $10,000 and $24,000 at September 30, 2014 and December 31, 2013, respectively, which is included in Other current assets in the Consolidated Balance Sheet. See additional information in Note 11.

Subsequent events: We have evaluated potential subsequent events through the date the financial statements were issued.

Recent Accounting Pronouncements: In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for the Company in the first quarter of fiscal year 2017.  The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on the consolidated financial statements.

Earnings (loss) per share: Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares assumed to be outstanding during the period of computation. Diluted earnings per share is computed similar to basic earnings per share except that the numerator is adjusted for the change in fair value of the warrant liability (only if dilutive) and the denominator is increased to include the number of dilutive potential common shares outstanding during the period using the treasury stock method.

Basic net loss and diluted net loss per share data were computed as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net (loss) for basic earnings per share
$
(4,797,062
)
 
$
(3,066,376
)
 
$
(11,469,659
)
 
$
(9,848,164
)
Change in fair value of warrant liability
129,000

 

 
324,000

 
4,096,000

Net (loss) for diluted earnings per share
$
(4,926,062
)
 
$
(3,066,376
)
 
$
(11,793,659
)
 
$
(13,944,164
)
Denominator:

 

 

 

Weighted-average basic common shares outstanding
9,575,789

 
5,055,591

 
9,386,613

 
3,463,730

Assumed conversion of dilutive securities:

 

 

 

Common stock purchase warrants

 

 
16,632

 
4,897

Potentially dilutive common shares

 

 
16,632

 
4,897

Denominator for diluted earnings per share – adjusted weighted-average shares
9,575,789

 
5,055,591

 
9,403,245

 
3,468,627

Basic net (loss) per share
$
(0.50
)
 
$
(0.61
)
 
$
(1.22
)
 
$
(2.84
)
Diluted net (loss) per share
$
(0.51
)
 
$
(0.61
)
 
$
(1.25
)
 
$
(4.02
)

The following table summarizes potentially dilutive adjustments to the weighted average number of common shares which were excluded from the calculation because their effects were antidilutive:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Common stock purchase warrants
1,531,696

 
1,843,582

 
1,531,696

 
1,843,582

Stock options
1,461,724

 
506,294

 
1,461,724

 
506,294

Restricted shares of common stock
105,833

 

 
105,833

 

 
3,099,253

 
2,349,876

 
3,099,253

 
2,349,876


14




15


Note 3.     Revenue and Accounts Receivable

Revenue by service type for the three and nine months ended September 30, 2014 and 2013 is comprised of the following: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Biopharma Services
$
1,930,799

 
$
746,212

 
$
2,830,687

 
$
1,920,165

Clinical Services
1,237,831

 
858,934

 
3,279,988

 
2,735,297

Discovery Services
53,220

 

 
53,220

 

Grants

 
100,000

 

 
100,000

 
$
3,221,850

 
$
1,705,146

 
$
6,163,895

 
$
4,755,462


Accounts receivable by service type at September 30, 2014 and December 31, 2013 consists of the following: 

September 30,
2014
 
December 31,
2013
Biopharma Services
$
2,381,335

 
$
428,341

Clinical Services
1,613,842

 
1,174,698

Discovery Services
149,390

 

Grants

 

Allowance for doubtful accounts
(36,000
)
 
(36,000
)

$
4,108,567

 
$
1,567,039


Revenue for Biopharma Services are services and tests provided to pharmaceutical companies and clinical research organizations in connection with studies for product development. Clinical Services are tests performed for patients at the request of a prescribing physician. These tests can be billed to Medicare, another third party insurer or the referring community hospital or other healthcare facility. Discovery Services are services provided in the development of new testing assays and methods. Grants includes revenue from grants (2013 only). The breakdown of our Clinical Services revenue (as a percent of total revenue) is as follows:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Medicare
9%
 
13%
 
13%
 
13%
Other insurers
14%
 
15%
 
21%
 
23%
Other healthcare facilities
15%
 
22%
 
19%
 
22%
 
38%
 
50%
 
53%
 
58%

We have historically derived a significant portion of our revenue from a limited number of test ordering sites. The top five test ordering sites during the three months ended September 30, 2014 and 2013 accounted for 59% and 75% respectively, of our clinical testing volumes, with 45% and 36% respectively, of the volume coming from community hospitals. During the three months ended September 30, 2014, there were two sites which accounted for approximately 10% or more of our total revenue. Two Biopharma clients accounted for approximately 17% and 12% of total revenue, respectively. During the three months ended September 30, 2013, there were two sites which accounted for approximately 10% or more of our total revenue. A Biopharma client and Clinical Services client accounted for approximately 44% and 10% of total revenue, respectively.

The top five test ordering sites during the nine months ended September 30, 2014 and 2013 accounted for 58% and 71% respectively, of our clinical testing volumes, with 40% and 37% respectively, of the volume coming from community hospitals. During the nine months ended September 30, 2014, there was one site which accounted for approximately 10% or more of our total revenue. A Biopharma client accounted for approximately 22% of our total revenue. During the nine months ended September 30, 2013, there was one site which accounted for approximately 10% or more of our total revenue. A Biopharma client accounted for approximately 40% of our total revenue. While we have agreements with our Biopharma clients, volumes from these clients are subject to the progression and continuation of the trials which can impact testing volume. We generally do not have formal written agreements with other testing sites and, as a result, we may lose these significant test ordering sites at any time.

16



Note 4. Notes Payable and Line of Credit

Below is a summary of our short-term and long-term debt obligations as of September 30, 2014 and December 31, 2013: 
 
September 30,
2014
 
December 31,
2013
Secured Note Payable, short-term
$

 
$
22,298

Notes Payable, Current Portion
280,854

 
22,298

Line of Credit, Principal Balance
$
6,000,000

 
$
6,000,000

Line of Credit, Current Portion

 
6,000,000

Lines of Credit, Long-Term
$
6,000,000

 
$


Business Line of Credit — Wells Fargo

At September 30, 2013 and December 31, 2013, we had fully utilized a line of credit (“Line”) with Wells Fargo Bank which provided for maximum borrowings of $6 million. Interest on the Line was due monthly equal to 1.75% above the Daily One Month LIBOR rate (2.0% at March 31, 2014). The Line required the repayment of principal, and any unpaid interest, in a single payment due upon maturity. The Line matured April 1, 2014, was guaranteed by John Pappajohn, our Chairman of the Board of Directors and significant shareholder, and was collateralized by a first lien on all of our assets including the assignment of our approved and pending patent applications.

On April 1, 2014 we entered into a credit agreement (the “Credit Agreement”) and re-negotiated the terms of the Line with Wells Fargo Bank. Under the terms of the Credit Agreement we maintain the Line with maximum borrowings of $6 million which have been fully drawn. The Line has been extended through April 1, 2016 at a rate of interest equal to LIBOR plus 1.75% (2.0% at September 30, 2014). The facility requires monthly interest payments. The pledge of all of our assets and intellectual property, as well as the guarantee by Mr. Pappajohn, was released and instead we restricted $6.0 million in cash, which is invested in an interest bearing certificate of deposit, as collateral. Additionally, we are required to limit capital spending and are restricted as to the amount we may pledge as collateral for additional borrowings from any source. The Credit Agreement requires the repayment of principal, and any unpaid interest, in a single payment due upon maturity. As result of the extension of the maturity date and the transfer of cash to Wells Fargo as collateral, we have presented the line of credit as a long-term liability and the cash collateral as restricted cash at September 30, 2014. The cash will remain restricted until such time as the Line is repaid.

Note 5. Letter of Credit

During 2013 we restricted an additional $50,000 in cash and secured a $300,000 letter of credit in favor of our landlord pursuant to the terms of the lease for our Rutherford facility. At September 30, 2014 the letter of credit was fully secured by the restricted cash disclosed on our Consolidated Balance Sheet.

Note 6. Capital Stock

IPO

On April 10, 2013, we completed our IPO in which we issued and sold 690,000 shares of common stock (including the underwriter’s overallotment of 90,000 shares) at a public offering price of $10.00 per share, resulting in gross proceeds of $6.9 million (net proceeds of $5 million). Upon closing of the IPO, all outstanding shares of Series A preferred stock were converted into 376,525 shares of common stock, and all outstanding shares of Series B preferred stock were converted into 910,800 shares of common stock. Also upon closing of the IPO, $9.6 million of debt converted into 963,430 shares of common stock. Concurrent with the IPO, certain derivative warrants with a fair value of $7.2 million were reclassified into equity due to the lapsing of anti-dilution provisions in the warrants. Also concurrent with the IPO, we issued 2,000 shares of common stock to Cleveland Clinic pursuant to our license agreement with Cleveland Clinic.

Secondary Offering

On August 19, 2013, we sold 1,500,000 shares of common stock at a public offering price of $10.00 per share resulting in gross proceeds of $15.0 million ($13.3 million of net proceeds after offering expenses and underwriting discounts). We used $3.5 million of the proceeds to repay certain indebtedness which was due on August 15, 2013. On September 5, 2013, we sold

17


105,000 additional common shares pursuant to the underwriter’s partial exercise of the over-allotment option which resulted in gross proceeds of $1.1 million ($947,000 of net proceeds after offering expenses and underwriting discounts). All references to the sales of common stock mentioned in this paragraph are referred to as the “Secondary Offering.”

Follow-On Offering

On October 28, 2013, we sold 3,286,700 shares of common stock (including the underwriter’s overallotment of 428,700 shares), at a public offering price of $14.00 per share resulting in gross proceeds of $46.0 million (net proceeds of $42.3 million). All references to the sales of common stock mentioned in this paragraph are referred to as the “Follow-On Offering.”

Preferred Stock

We are currently authorized to issue up to 9,764,000 shares of preferred stock. There are no shares issued or outstanding.

18


Note 7. Stock Option Plans

We have two equity incentive plans: the 2008 Stock Option Plan (the “2008 Plan”) and the 2011 Equity Incentive Plan (the “2011 Plan”, and together with the 2008 Plan, the “Stock Option Plans”). The Stock Option Plans are meant to provide additional incentive to officers, employees and consultants to remain in our employment. Options granted are generally exercisable for up to 10 years.

The Board of Directors adopted the 2011 Plan on June 30, 2011 and reserved 350,000 shares of common stock for issuance under the 2011 Plan. On May 22, 2014, the stockholders voted to increase the number of shares reserved by the plan to 2,000,000 shares of common stock under several types of equity awards including stock options, stock appreciation rights, restricted stock awards and other awards defined in the 2011 Plan.

The Board of Directors adopted the 2008 Plan on April 29, 2008 and reserved 251,475 shares of common stock for issuance under the plan. On April 1, 2010, the stockholders voted to increase the number of shares reserved by the plan to 550,000. We are authorized to issue incentive stock options or non-statutory stock options to eligible participants.

We have also issued 48,000 options outside of the Stock Option Plans, which are no longer outstanding.

At September 30, 2014, 893,788 shares remain available for future awards under the 2011 Plan and 51,541 shares remain available for future awards under the 2008 Plan.

As of September 30, 2014, no stock appreciation rights and 122,500 shares of restricted stock have been awarded under the Stock Option Plans.

Prior to our IPO in April 2013, the Board of Directors authorized an offer to certain employee and non-employee options holders on the following terms: those holding stock options with a strike price of $25.00 or more had the opportunity to exchange their options for 60% of the number of options currently held with an exercise price equal to the IPO price, which was $10.00 per share, and those holding stock options with a strike price of $12.50 had the opportunity to exchange their options for 80% of the number of options currently held with an exercise price equal to the IPO price which was $10.00 per share. On April 5, 2013, our initial public offering became effective and 336,300 options with exercise prices ranging from $12.50 to $33.80 were exchanged for 242,070 options with an exercise price of $10.00. The exchange of the options did not result in the recognition of incremental compensation cost. In addition, 53,500 options which were approved to be issued and priced at the IPO price were issued to employees with an exercise price of $10.00 per share.

A summary of employee and non-employee stock option activity for year ended December 31, 2013 and the nine months ended September 30, 2014 is as follows:
 
Options Outstanding
 
Weighted-
Average
Remaining
Contractual
Term (in years)
 
Aggregate
Intrinsic
Value
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
 
Outstanding January 1, 2013
553,340

 
$
12.76

 
7.13
 
$
1,142,432

Granted
426,762

 
14.57

 
 
 
 
Exercised
(164
)
 
10.00

 
 
 
 
Cancelled or expired
(106,396
)
 
20.46

 
 
 
 
Outstanding December 31, 2013
873,542

 
$
10.83

 
7.75
 
$
3,138,539

Granted
695,900

 
13.11

 
 
 
 
Exercised
(30,083
)
 
6.61

 
 
 
 
Cancelled or expired
(77,635
)
 
11.67

 
 
 
 
Outstanding September 30, 2014
1,461,724

 
$
11.95

 
8.09
 
$
854,839

Exercisable September 30, 2014
484,029

 
$
8.76

 
5.45
 
$
846,800


Aggregate intrinsic value represents the difference between the estimated fair value of our common stock and the exercise price of outstanding, in-the-money options. The fair value of our common stock was $9.00 at September 30, 2014 and $13.78 at December 31, 2013, based on the closing price on the NASDAQ Capital Market.


19


As of September 30, 2014, total unrecognized compensation cost related to non-vested stock options and restricted stock granted to employees was $6,563,115 which we expect to recognize over the next 3.54 years.

As of September 30, 2014, total unrecognized compensation cost related to non-vested stock options granted to non-employees was $1,047,224 which we expect to recognize over the next 3.14 years. The estimate of unrecognized non-employee compensation is based on the fair value of the non-vested options as of September 30, 2014.

The following table summarizes information about outstanding and vested stock options granted to employees and non-employees as of September 30, 2014 as follows:
 
Options Outstanding
 
Options Vested and Exercisable
Exercise Price
Number of
Shares
Outstanding
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contract
Life (in Years)
 
Number of
Shares
 
Weighted-
Average
Exercise Price
4.00
145,000

 
$
4.00

 
4.47
 
145,000

 
$
4.00

4.80
30,914

 
4.80

 
5.31
 
29,000

 
4.80

9.09
230,900

 
9.09

 
9.99
 

 

10.00
267,038

 
10.00

 
5.13
 
236,707

 
10.00

11.70 - 11.75
75,740

 
11.70

 
9.54
 
1,586

 
11.75

12.50 - 14.18
105,700

 
13.99

 
9.26
 
150

 
12.50

15.39
316,432

 
15.39

 
9.01
 
37,586

 
15.39

15.89
200,000

 
15.89

 
9.65
 
25,000

 
15.89

17.38
90,000

 
17.38

 
9.47
 
9,000

 
17.38

Total
1,461,724

 
$
11.95

 
8.09
 
484,029

 
$
8.76


The fair value of options granted to employees is estimated on the grant date using the Black-Scholes option valuation model. This valuation model for stock-based compensation expense requires us to make assumptions and judgments about the variables used in the calculation, including the fair value of our common stock prior to our IPO (see Note 9), the expected term (the period of time that the options granted are expected to be outstanding), the volatility of our common stock, a risk-free interest rate, and expected dividends. To the extent actual forfeitures differ from the estimates, the difference will be recorded as a cumulative adjustment in the period estimates are revised. No compensation cost is recorded for options that do not vest. We use the simplified calculation of expected life described in the SEC’s Staff Accounting Bulletin No. 107, Share-Based Payment, and volatility is based on an average of the historical volatilities of the common stock of three entities with characteristics similar to those of the Company. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option. We use an expected dividend yield of zero, as we do not anticipate paying any dividends in the foreseeable future. Expected forfeitures are assumed to be zero due to the small number of plan participants and the plan design which has monthly vesting after an initial cliff vesting period.

The following table presents the weighted-average assumptions used to estimate the fair value of options granted to employees during the periods presented:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2014
 
2013
Volatility
75.02%
 
75.04
%
 
77.11
%
Risk free interest rate
2.02%
 
1.84
%
 
0.76
%
Dividend yield
0.00%
 
0.00
%
 
0.00
%
Term (years)
6.29
 
6.10

 
5.95

Weighted-average fair value of options granted during the period
6.13
 
6.86

 
6.72





20


In 2010, we issued an aggregate of 80,000 options to non-employees with an exercise price of $25.00. As described above, on April 5, 2013, these options were exchanged for 48,000 options with an exercise price of $10.00. In October 2013, we issued 10,000 options to a non-employee with an exercise price of $15.39. In May 2014, we issued 200,000 options to a our Director, Raju Chaganti, with an exercise price of $15.89. See Note 12 for additional information. The following table presents the weighted-average assumptions used to estimate the fair value of options reaching their measurement date for non-employees during the periods presented:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Volatility
71.30
%
 
75.32
%
 
71.87
%
 
75.87
%
Risk free interest rate
2.43
%
 
1.93
%
 
2.53
%
 
1.40
%
Dividend yield
0.00
%
 
0.00
%
 
0.00
%
 
0.00
%
Term (years)
9.58

 
7.21

 
9.79

 
7.50


The following table presents the effects of stock-based compensation related to stock option awards to employees and non-employees on our Statement of Operations during the periods presented:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenues
$
26,200

 
$
8,442

 
$
67,109

 
$
22,621

Research and development
188,633

 
28,516

 
345,803

 
119,314

General and administrative
593,715

 
71,268

 
1,615,359

 
223,535

Sales and marketing
27,551

 
9,107

 
101,609

 
41,731

Total stock-based compensation
$
836,099

 
$
117,333

 
$
2,129,880

 
$
407,201



21


Note 8. Warrants

We have issued certain warrants which contain an exercise price adjustment feature in the event we issue additional equity instruments at a price lower than the exercise price of the warrant. The warrants are described herein as derivative warrants. For all derivative warrants, in the event equity instruments are issued at a price lower than the exercise price of the warrant, the exercise price is adjusted to the price of the new equity instruments issued (price adjustment feature). For certain of these warrants, the number of shares underlying the warrant is also adjusted to an amount computed by dividing the proceeds of the warrant under its original terms by the revised exercise price (share adjustment feature). These warrants are initially recorded as a warrant liability at fair value with a corresponding entry to the loan guarantee fee asset, debt discount, additional paid-in capital or expense dependent upon the service provided in exchange for the warrant grant. As of September 30, 2014 all warrants with a share adjustment feature have either expired or have been exercised.
In January 2014, the Company received $950 from a warrant holder who exercised warrants to purchase 95 shares of common stock at $10.00 per share. In February 2014 a warrant holder exercised warrants to purchase 3,320 shares of common stock at an exercise price of $10.00 per share using the net issuance exercise method whereby 1,661 shares were surrendered in payment in full of the exercise price resulting in a net issuance of 1,659 shares. In March 2014 a warrant holder exercised warrants to purchase 12,500 shares of common stock at an exercise price of $10.00 per share using the net issuance exercise method whereby 7,230 shares were surrendered in payment in full of the exercise price resulting in a net issuance of 5,270 shares. In June 2014, the company received $177,154 from Mr. Pappajohn who exercised warrants to purchase 44,288 shares of common stock at an exercise price of $4.00 per share.

In July 2014, warrant holders exercised warrants to purchase 130,000 shares of common stock at an exercise price of $4.00 per share using the net issuance exercise method whereby 45,894 shares were surrendered in payment in full of the exercise price resulting in a net issuance of 84,106 shares.

The following table summarizes the warrant activity for the nine months ended September 30, 2014: 
Issued With / For
Exercise
Price
 
Warrants
Outstanding
January 1,
2014
 
2014 Warrants Exercised
 
Warrants Outstanding September 30, 2014
Non-Derivative Warrants:
 
 
 
 
 
 
 
Financing
$
10.00

  
243,334

 

 
243,334

Financing
15.00

  
436,079

 

 
436,079

Debt Guarantee
4.00

  
174,288

 
(174,288
)
 

Debt Guarantee
10.00

  
237,500

 

 
237,500

Debt Guarantee
15.00

  
585,645

 

 
585,645

Consulting
10.00

  
29,138

 

 
29,138

Total Non-Derivative Warrants
$
13.34

1,705,984

 
(174,288
)
 
1,531,696

Derivative Warrants:
 
 
 
 
 
 
 
Financing
$
10.00

60,000

 

 
60,000

Debt Guarantee
10.00

12,500

 
(12,500
)
 

Series B Pref. Stock
10.00

18,430

 
(3,415
)
 
15,015

Consulting
10.00

200

 

 
200

Total Derivative Warrants
10.00

91,130

 
(15,915
)
 
75,215

Total
$
13.18

1,797,114

 
(190,203
)
 
1,606,911


A
These warrants are subject to fair value accounting and contain exercise price and number of share adjustment features. See Note 9.
B
These warrants are subject to fair value accounting and contain an exercise price adjustment feature. See Note 9.
C
Weighted average exercise prices are as of September 30, 2014.

22


Note 9. Fair Value of Warrants
The following tables summarize the assumptions used in computing the fair value of derivative warrants subject to fair value accounting at the date of issue during the nine months ended September 30, 2014 and 2013, and at September 30, 2014, December 31, 2013 and April 5, 2013 (IPO valuation date). In computing the fair value of the warrants, if the stated exercise price of the warrants exceeded the assumed value of the Company stock at the date the fair value was being computed, the exercise price and number of shares (if applicable) underlying the warrants were adjusted to reflect an assumed trigger of the price and/or share adjustment features related to the applicable warrants. Such adjustments were only applicable to the nine months ended September 30, 2013 due to the relative price of the warrants and the assumed Company stock price.

Issued with Debt Guarantee
Exercised During the Nine Months Ended September 30, 2014
 
As of December 31, 2013
 
IPO Date April 5, 2013
Exercise Price
$
10.00

 
$
10.00

 
$
13.56

Expected life (years)
0.60

 
0.83

 
2.42

Expected volatility
49.01
%
 
57.33
%
 
66.37
%
Risk-free interest rate
0.08
%
 
0.13
%
 
0.32
%
Expected dividend yield
%
 
%
 
%
 
Issued with Series B Preferred Shares
Exercised During the Nine Months Ended September 30, 2014
 
As of September 30, 2014
 
As of December 31, 2013
Exercise Price
$
10.00

 
$
10.00

 
$
10.00

Expected life (years)
1.72

 
1.13

 
1.92

Expected volatility
46.60
%
 
47.45
%
 
59.26
%
Risk-free interest rate
0.33
%
 
0.13
%
 
0.38
%
Expected dividend yield
%
 
%
 
%
Issued for Consulting
As of September 30, 2014
 
As of December 31, 2013
 
IPO Date April 5, 2013
Exercise Price
$
10.00

 
$
10.00

 
$
10.00

Expected life (years)
1.39

 
2.14

 
2.33

Expected volatility
48.34
%
 
63.63
%
 
63.20
%
Risk-free interest rate
0.13
%
 
0.38
%
 
0.27
%
Expected dividend yield
%
 
%
 
%
 
Issued with Financing
Exercised During the Nine Months Ended September 30, 2014
 
As of September 30, 2014
 
As of December 31, 2013
 
IPO Date April 5, 2013
Exercise Price
$
13.34

 
$
10.00

 
$
10.00

 
$
13.21

Expected life (years)
9.78

 
1.48

 
2.25

 
8.30

Expected volatility
74.70
%
 
48.60
%
 
64.40
%
 
73.22
%
Risk-free interest rate
1.95
%
 
0.13
%
 
0.38
%
 
1.44
%
Expected dividend yield
%
 
%
 
%
 
%

The assumed Company stock price used in computing the fair value of warrants exercised during the nine months ended September 30, 2014 was $15.20$19.86 and for the fair value of warrants issued during the nine months ended September 30, 2013, the assumed range of Company stock prices used was $9.60$9.96. In determining the fair value of warrants issued at each reporting date, the Company stock price was $9.00 at September 30, 2014 and $13.78 at December 31, 2013 based on the closing price on the NASDAQ Capital Market.

23



The following table summarizes the derivative warrant activity subject to fair value accounting for the nine months ended September 30, 2014:
Issued with/for
Fair value of
warrants
outstanding as of
December 31, 2013
 
Fair value
of warrants
exercised
 
Change in
fair value
of warrants
 
Fair value of
warrants
outstanding as of
September 30, 2014
Series B Preferred Stock
$
117,000

 
$
(38,000
)
 
$
(54,000
)
 
$
25,000

Debt Guarantee
64,000

 
(87,000
)
 
23,000

 

Consulting
1,000

 

 

 
1,000

Financing
412,000

 

 
(293,000
)
 
119,000

 
$
594,000

 
$
(125,000
)
 
$
(324,000
)
 
$
145,000



24


Note 10. Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Measurements and Disclosures Topic of the FASB Accounting Standards Codification requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the Topic establishes a fair value hierarchy for valuation inputs that give the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.

Level 2: Significant other 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.

Level 3: Significant unobservable inputs that reflect our own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following table summarizes the financial liabilities measured at fair value on a recurring basis segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

 
September 30, 2014
 
Total
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Warrant liability
$
145,000

 

 

 
$
145,000

Gentris contingent consideration
283,000

 

 

 
283,000

Notes payable to VenturEast
733,387

 

 

 
733,387

 
$
1,161,387

 
$

 
$

 
$
1,161,387

 
 
 
 
 
 
 
 
 
December 31, 2013
 
Total
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Warrant liability
$
594,000

 

 

 
$
594,000


The warrant liability consists of stock warrants we issued that contain an exercise price adjustment feature. In accordance with derivative accounting for warrants, we calculated the fair value of warrants and the assumptions used are described in Note 9, “Fair Value of Warrants”. Realized and unrealized gains and losses related to the change in fair value of the warrant liability are included in Other income (expense) on the Statement of Operations. A table summarizing the activity for the derivative warrant liability which is measured at fair value using Level 3 inputs is presented in Note 9.

Under the terms of the Gentris acquisition we must pay additional consideration if Gentris’ revenue exceeds certain thresholds in the first year following the acquisition. On the acquisition date, we determined that this earn-out obligation had a fair value of $283,000 based upon a probability weighted analysis. Under the terms of the BioServe acquisition we will make a payment to VenturEast equal to the market value of 84,278 shares of our common stock within thirty months from the acquisition date. Using our stock price adjusted for certain discounts, we determined the 84,278 shares of common stock had a fair market value of $733,387.
  

25




26


Note 11. Joint Venture Agreement

In November 2011, we entered into an affiliation agreement with the Mayo Foundation for Medical Education and Research (“Mayo”), subsequently amended. Under the agreement, we formed a joint venture with Mayo in May 2013 to focus on developing oncology diagnostic services and tests utilizing next generation sequencing. The joint venture is a limited liability company, with each party initially holding fifty percent of the issued and outstanding membership interests of the new entity (the “JV”). In exchange for our membership interest in the JV, we made an initial capital contribution of $1.0 million in October 2013. In addition, we issued 10,000 shares of our common stock to Mayo pursuant to our affiliation agreement and recorded an expense of approximately $175,000. We also recorded additional expense of approximately $231,000 during the fourth quarter of 2013 related to shares issued to Mayo in November of 2011 as the JV achieved certain performance milestones. In the third quarter of 2014 we made an additional $1.0 million capital contribution.

The agreement also requires aggregate total capital contributions by us of up to an additional $4.0 million. We currently anticipate that we will make capital contributions of $1.0 million in the first quarter of 2015. The timing of the remaining installments is subject to the JV's achievement of certain operational milestones agreed upon by the board of governors of the JV. In exchange for its membership interest, Mayo’s capital contribution will take the form of cash, staff, services, hardware and software resources, laboratory space and instrumentation, the fair market value of which will be approximately equal to $6.0 million. Mayo’s continued contribution will also be conditioned upon the JV’s achievement of certain milestones.


27


Note 12. Related Party Transactions

John Pappajohn, a member of the Board of Directors and stockholder, had personally guaranteed our revolving line of credit with Wells Fargo Bank through March 31, 2014. As consideration for his guarantee, as well as each of the eight extensions of this facility through March 31, 2014, Mr. Pappajohn received warrants to purchase an aggregate of 1,051,506 shares of common stock of which Mr. Pappajohn assigned warrants to purchase 284,000 shares of common stock to certain third parties. Warrants to purchase 440,113 shares of common stock have been exercised by Mr. Pappajohn through September 30, 2014. After adjustment pursuant to the terms of the warrants in conjunction with our IPO, the number of these warrants outstanding retained by Mr. Pappajohn was 585,645 at $15.00 per share.

In addition, John Pappajohn also had loaned us an aggregate of $6,750,000 (all of which was converted into 675,000 shares of common stock at the IPO price of $10.00 per share). In connection with these loans, Mr. Pappajohn received warrants to purchase an aggregate of 202,630 shares of common stock. After adjustment pursuant to the terms of the warrants in conjunction with our IPO, the number of warrants outstanding was 436,079 at $15.00 per share at September 30, 2014.

Effective January 6, 2014, the board of directors appointed John Pappajohn to serve as the Chairman of the Board, a position previously held by Dr. Raju S.K. Chaganti. As compensation for serving as the Chairman of the Board, the Company will pay Mr. Pappajohn $100,000 per year and granted to Mr. Pappajohn 25,000 restricted shares of the Company's common stock, and options to purchase an aggregate of 100,000 shares of the Company's common stock. The options have a term of ten years from the date on which they were granted. The restricted stock and the options each vest in two equal installments on the one year anniversary and the two year anniversary of the date on which Mr. Pappajohn became the Chairman of the Board.

In August 2010, we entered into a consulting agreement with Equity Dynamics, Inc (“EDI”)., an entity controlled by John Pappajohn, pursuant to which EDI received a monthly fee of $10,000. The consulting agreement was terminated effective March 31, 2014. Subsequently the Company entered into a new consulting agreement with EDI effective April 1, 2014 pursuant to which it will receive a monthly fee of $10,000. Total expenses for the three months ended September 30, 2014 and 2013 were $30,000 and $30,000, respectively and for the nine months ended September 30, 2014 and 2013 were$90,000 and $90,000, respectively. As of September 30, 2014, we owed Equity Dynamics, Inc. $0.

On May 19, 2006, we issued a convertible promissory note in favor of our then Chairman and founder, Dr. Chaganti, the holder, which obligated us to pay the holder the sum of $100,000, together with interest at the rate of 8.5% per annum, due April 1, 2014. Interest expense totaled $2,400 through April 10, 2013. On April 10, 2013 the note and accrued interest converted into 13,430 shares of common stock at the IPO price of $10.00 per share. Pursuant to a consulting and advisory agreement, Dr. Chaganti also received options to purchase a total of 36,000 shares of common stock at a price of $10.00 per share which vested over a two year period. Total non-cash stock-based compensation recognized under the consulting agreement for each of the six month periods ended June 30, 2014 and 2013 were $0 and $54,650, respectively. Additionally, on September 15, 2010, we entered into a three year consulting agreement with Dr. Chaganti which was subsequently renewed through December 31, 2016 pursuant to which Dr. Chaganti receives $5,000 per month for providing consulting and technical support services. Total expenses for each of the quarterly periods ended September 30, 2014 and 2013 were $15,000. Pursuant to the terms of the renewed consulting agreement, Dr. Chaganti received an option to purchase 200,000 shares of our common stock at a purchase price of $15.89 per share vesting over a period of four years. Total non-cash stock-based compensation recognized under the consulting agreement for each of the nine months ended September 30, 2014 and 2013 were $288,500 and $0, respectively. Also pursuant to the consulting agreement, Dr. Chaganti assigned to us all rights to any inventions which he may invent during the course of rendering consulting services to us. In exchange for this assignment, if the USPTO issues a patent for an invention on which Dr. Chaganti is listed as an inventor, we are required to pay Dr. Chaganti (i) a one-time payment of $50,000 and (ii) 1% of any net revenues we receive from any licensed sales of the invention. In 2014 we paid Dr. Chaganti $150,000 which was recognized as an expense in fiscal 2013 when three patents were issued.

Subsequent Event
On October 19, 2014, 233,333 warrants held by Mr. Pappajohn expired unexercised.
On October 21, 2014 a patent was issued for which we are required to pay Dr. Chaganti a one-time payment of $50,000.



28


Note 13. Contingencies

In the normal course of business, the Company may become involved in various claims and legal proceedings. In the opinion of management, the ultimate liability or disposition thereof is not expected to have a material adverse effect on our financial condition, results of operations, or liquidity.

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

As used herein, the “Company,” “we,” “us,” “our” or similar terms, refer to Cancer Genetics, Inc. and its wholly owned subsidiaries: Cancer Genetics Italia, S.r.l., Gentris, LLC and BioServe Biotechnologies (India) Private Limited, except as expressly indicated or unless the context otherwise requires. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help facilitate an understanding of our financial condition and our historical results of operations for the periods presented. This MD&A should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Reporting on Form10-K filed with the SEC on March 28, 2014. This MD&A may contain forward-looking statements that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” below.

Overview

We are an emerging leader in the field of genomic-based cancer diagnostics. The products and services we are developing are poised to transform cancer patient management, increase treatment efficacy, and reduce healthcare costs. We target cancers where prognosis information is critical and where predicting treatment outcomes using currently available techniques is limited. These cancers include hematological, urogenital and HPV-associated cancers. We seek to provide our tests and services to oncologists and pathologists at hospitals, cancer centers and physician offices, as well as to biopharmaceutical companies and clinical research organizations for their clinical trials.

Our services are performed at our state-of-the-art laboratories located in New Jersey, North Carolina, Shanghai (China), and Hyderabad, India. Our laboratories comply with the highest regulatory standards as appropriate for the services they deliver including CLIA, CAP, NY State and NABL (India). Our scientific and clinical advisory boards include leading specialists in clinical oncology, as well as industry thought leaders working to drive adoption of our unique tests and services globally.  Our services are built on a foundation of world-class scientific knowledge and intellectual property in solid and blood-borne cancers, as well as strong academic relationships with major cancer centers such as Memorial Sloan-Kettering, Mayo Clinic, and the National Cancer Institute.

Our revenue is generated principally through our clinical laboratory services. Most of our sales consist of our non-proprietary testing services to a limited number of oncologists, pathologists, community hospitals and biotechnology and pharmaceutical companies located mostly in the eastern and midwestern United States. Our non-proprietary laboratory testing services include molecular testing, sequencing, mutational analysis, flow cytometry testing, histology testing and cytology testing.

Our proprietary tests are based principally on our expertise in specific cancer types, test development methodologies and proprietary algorithms correlating genetic events with disease specific information. We have commercially launched MatBA®-CLL, our first proprietary microarray test for chronic lymphocytic leukemia (“CLL”) for use in our CLIA-accredited clinical laboratory. In January 2012, we received CLIA approval for MatBA®-SLL, our proprietary microarray for risk stratification in small lymphocytic lymphoma (“SLL”), and we are currently offering MatBA®-SLL in our laboratory. In February 2013, we received CLIA approval for MatBA®-DLBCL, our proprietary microarray for diagnosis, prognosis and patient monitoring in diffuse large B cell lymphoma (“DLBCL”). In May 2013, we commercially launched UroGenRA™, our proprietary microarray for the diagnosis and prognosis of patients with kidney cancer for use in our CLIA-accredited clinical laboratory. We have also launched FHACT for cervical cancer outside the United States. In addition, we are developing a series of other proprietary genomic tests in our core oncology markets.

The non-proprietary testing services we offer are focused on specific oncology categories where we are developing our proprietary arrays and probe panels. We believe that there is significant synergy in developing and marketing a complete set of tests and services that are disease-focused and delivering those tests and services in a comprehensive manner to help with treatment decisions. The insight that we develop in delivering the non-proprietary services are often leveraged in the development of our proprietary programs and now increasingly in the validation of our proprietary programs (such as MatBA®) for clinical use.


29


We expect to continue to incur significant losses for the near future. We incurred losses of $12.4 million and $6.7 million for fiscal years ended December 31, 2013 and 2012, respectively, and incurred a net loss of $11.5 million for the nine months ended September 30, 2014. As of September 30, 2014, we had an accumulated deficit of $72.8 million.

Acquisition - Gentris Corporation

On July 16, 2014, we purchased substantially all of the assets of Gentris Corporation, a Delaware corporation (“Gentris”), with its principal place of business in North Carolina, for aggregate consideration of approximately $4.8 million. Gentris provides genomic testing and pharmacogenomics services to half of the top ten biopharma companies globally and has participated and performed genomic analysis for over 1,000 clinical trials. See Note 1 to the financial statements for additional information regarding the acquisition.

Acquisition - BioServe India

On August 18, 2014 we acquired BioServe BioTechnologies (India) Private Limited, an Indian corporation (“BioServe”) for an aggregate purchase price of approximately $1.1 million.

BioServe is a leading genomic service and next-generation sequencing company serving both the research and clinical markets and based in Hyderabad, India. With the BioServe acquisition we believe we will be able to access the Indian healthcare market. See Note 1 to the financial statements for additional information regarding the BioServe acquisition.

Key Factors Affecting our Results of Operations and Financial Condition

Our overall long-term growth plan is predicated on our ability to develop and commercialize our proprietary tests outside of our clinical laboratory, penetrate the BioPharma community and achieve more revenue supporting clinical trials and develop and penetrate the Indian market. In 2014 we acquired Gentris to increase our penetration in the BioPharma space. In 2014 we also acquired BioServe to launch services in the Indian market. Since early 2011 we have launched 6 proprietary tests for use in our clinical laboratory s including MatBA®-CLL, MatBA®-SLL, MatBA®-DLBCL, UroGenRA™ and FHACT®. We continue to develop additional proprietary tests. In order to market our tests to independent laboratories and testing facilities, we believe we will need to obtain approvals or clearances from the appropriate regulatory authorities. Without these approvals, the success of these commercialization efforts will be limited. To obtain these approvals and facilitate market adoption of our proprietary tests, we anticipate having to successfully complete additional studies with clinical samples and publish our results in peer-reviewed scientific journals. Our ability to complete such studies is dependent upon our ability to leverage our collaborative relationships with leading institutions to facilitate our research and obtain data for our quality assurance and test validation efforts.

We believe that the factors discussed in the following paragraphs have had and are expected to continue to have a material impact on our results of operations and financial condition.

Revenues

Our revenue is generated principally through our clinical laboratory services. The clinical laboratory industry is highly competitive, and our relationship with the decision-makers at hospitals, cancer centers, physician offices, or pharmaceutical companies is a critical component of securing their business. Consequently, our ability to attract and maintain productive sales personnel that have and can grow these relationships will largely determine our ability to grow our clinical services revenue. In order to grow our clinical laboratory revenue, we must continue to pursue validation studies and work with oncology thought leaders to develop and publish data that is helpful in supporting the need for our tests and services.

Due to the early stage nature of our clinical laboratory business and our limited sales and marketing activities to date, we have historically derived a significant portion of our revenue from a limited number of test ordering sites, although the test ordering sites that generate a significant portion of our revenue have changed from period to period. Our test ordering sites are largely hospitals, cancer centers, reference laboratories and physician offices, as well as biopharmaceutical companies as part of a clinical trial. Oncologists and pathologists at these sites order the tests on behalf of the needs of their oncology patients or as part of a clinical trial sponsored by a biopharmaceutical company in which the patient is being enrolled.

The top five test ordering sites during the three months ended September 30, 2014 and 2013 accounted for 59% and 75% respectively, of our clinical testing volumes, with 45% and 36% respectively, of the volume coming from community hospitals. During the three months ended September 30, 2014, there were two sites which accounted for approximately 10% or more of

30


our total revenue. Two Biopharma clients accounted for approximately 17% and 12% of total revenue, respectively. During the three months ended September 30, 2013, there were two sites which accounted for approximately 10% or more of our total revenue. A Biopharma client and Clinical Services client accounted for approximately 44% and 10% of total revenue, respectively.

The top five test ordering sites during the nine months ended September 30, 2014 and 2013 accounted for 58% and 71% respectively, of our clinical testing volumes, with 40% and 37% respectively, of the volume coming from community hospitals. During the nine months ended September 30, 2014, there was one site which accounted for approximately 10% or more of our total revenue. A Biopharma client accounted for approximately 22% of our total revenue. During the nine months ended September 30, 2013, there was one site which accounted for approximately 10% or more of our total revenue. A Biopharma client accounted for approximately 40% of our total revenue.

Revenue for Biopharma Services are services and tests provided to pharmaceutical companies and clinical research organizations in connection with studies for product development. Clinical Services are tests performed for patients at the request of a prescribing physician. These tests can be billed to Medicare, another third party insurer or the referring community hospital or other healthcare facility. Discovery Services are services provided in the development of new testing assays and methods. Grants includes revenue from grants (2013 only). The billing arrangements generally are dictated by our customers and in accordance with state and federal law.

Cost of Revenues

Our cost of revenues consists principally of internal personnel costs, including stock-based compensation, laboratory consumables, shipping costs, overhead and other direct expenses, such as specimen procurement and third party validation studies. We are pursuing various strategies to reduce and control our cost of revenues, including automating our processes through more efficient technology and attempting to negotiate improved terms with our suppliers. We successfully migrated key components of our probe manufacturing to India in 2013, which reduced the labor costs involved and increased manufacturing yield and flexibility. We will continue to assess how geographic advantage can help us improve our cost structure.

Operating Expenses

We classify our operating expenses into three categories: Research and Development, Sales and Marketing, and General and Administrative. Our operating expenses principally consist of personnel costs, including stock-based compensation, outside services, laboratory consumables and overhead, development costs, marketing program costs and legal and accounting fees.

Research and Development Expenses. We incur research and development expenses principally in connection with our efforts to develop our proprietary tests. Our primary research and development expenses consist of direct personnel costs, laboratory equipment and consumables and overhead expenses. We anticipate that research and development expenses will increase in the near-term, principally as a result of hiring additional personnel to develop and validate tests in our pipeline and to perform work associated with our research collaborations. In addition, we expect that our costs related to collaborations with research and academic institutions will increase. For example, in 2013 we entered into a joint venture with the Mayo Foundation for Medical Education and Research. All research and development expenses are charged to operations in the periods they are incurred.

Sales and Marketing Expenses. Our sales and marketing expenses consist principally of personnel and related overhead costs for our sales team and their support personnel, travel and entertainment expenses, and other selling costs including sales collaterals and trade shows. We have started to increase our sales and marketing and clinical efforts since our IPO and we expect our sales and marketing expenses to increase significantly as we expand into new geographies and add new clinical tests and services.

General and Administrative Expenses. General and administrative expenses consist principally of personnel-related expenses, professional fees, such as legal, accounting and business consultants, occupancy costs, and other general expenses. We have incurred increases in our general and administrative expenses and anticipate further increases as we expand our business operations. We further expect that general and administrative expenses will increase significantly due to increased information technology, legal, insurance, accounting and financial reporting expenses associated with being a public company.


31


Seasonality

Our business experiences decreased demand during spring vacation season, summer months and the December holiday season when patients are less likely to visit their health care providers. We expect this trend in seasonality to continue for the foreseeable future.


Results of Operations

Three Months Ended September 30, 2014 and 2013

The following table sets forth certain information concerning our results of operations for the periods shown: 
 
Three Months Ended September 30,
 
Change
(dollars in thousands)
2014
 
2013
 
$
 
%
Revenue
$
3,222

 
$
1,705

 
$
1,517

 
89
 %
Cost of revenues
2,566

 
1,211

 
1,355

 
112
 %
Research and development expenses
1,390

 
433

 
957

 
221
 %
General and administrative expenses
3,104

 
1,298

 
1,806

 
139
 %
Sales and marketing expenses
1,071

 
443

 
628

 
142
 %
Total operating loss
(4,909
)
 
(1,680
)
 
(3,229
)
 
192
 %
Interest (expense) income
(17
)
 
(353
)
 
336

 
(95
)%
Debt conversion costs

 

 

 
n/a

Change in fair value of warrant liability
129

 
(1,033
)
 
1,162

 
(112
)%
(Loss) before income taxes
(4,797
)
 
(3,066
)
 
(1,731
)
 
56
 %
Income tax (benefit) expense

 

 

 
 %
Net (loss)
$
(4,797
)
 
$
(3,066
)
 
$
(1,731
)
 
56
 %

Revenue

Revenue for Biopharma Services are services and tests provided to pharmaceutical companies and clinical research organizations in connection with studies for product development. Clinical Services are tests performed for patients at the request of a prescribing physician. These tests can be billed to Medicare, another third party insurer or the referring community hospital or other healthcare facility. Discovery Services are services provided in the development of new testing assays and methods. Grants includes revenue from grants (2013 only). The breakdown of our revenue is as follows:

 
Three Months Ended September 30,
 
Change
 
2014
 
2013
 
 
 
 
(dollars in thousands)
$
 
%
 
$
 
%
 
$
 
%
Biopharma Services
$
1,931

 
60
%
 
$
746

 
44
%
 
$
1,185

 
159
 %
Clinical Services
1,238

 
38
%
 
859

 
50
%
 
379

 
44
 %
Discovery Services
53

 
2
%
 

 
%
 
53

 
 %
Grants

 
%
 
100

 
6
%
 
(100
)
 
(100
)%
Total Revenue
$
3,222

 
100
%
 
$
1,705

 
100
%
 
$
1,517

 
89
 %

Revenue increased 89%, or $1,517,000 principally due to the acquisitions of Gentris and BioServe, whose revenue accounted for $1,384,000 of the increase. This along with increases in test volumes related to our clinical services were partially offset by lower volumes in our pre-acquisition Biopharma Services business and lower revenue from other sales of our probes. Our Clinical Services test volume increased 44% to 2,482 from 1,719 in the prior year period. Our average revenue per clinical services test increased by 4% to $484 per test, from $468 per test in the prior year period due to higher mix of proprietary versus non-proprietary tests ordered in the quarter. Our average revenue per test is dependent on the mix of tests and customers and can vary. Many factors could cause average revenue per test to decline including if direct bill clients continue to account for a larger part of our business and increased volumes of our proprietary FHACT® test for cervical cancer (which has a lower average selling price).


32


Cost of Revenues

Cost of revenues increased 112%, or $1,355,000, principally due to the following: Costs of revenue from the acquired businesses of $942,000. Lab supplies expense increased by $196,000, shipping costs increased by $85,000, outsourcing services increased by $65,000, and compensation costs increased by $24,000 due to higher test volume.

Operating Expenses

Research and Development Expenses. Research and development expenses increased 221%, or $957,000, principally due to the following: Our share of the loss from OncoSpire, our joint venture with Mayo Clinic, of $350,000 as it incurs research expenses related to the pursuit of developing new clinical tests. Stock-based compensation increased by $150,000, compensation costs increased by $305,000, and Research and Development supplies increased by $83,000 due to higher activity.

General and Administrative Expenses. General and administrative expenses increased 139%, or $1.8 million, principally due to the following: Costs from the acquired businesses of $515,000, stock-based compensation increased by $520,000, compensation increased by 131,000, consulting and outsourced services increased by $290,000, costs associated with being a public company increased by $241,000, and travel costs increased by $36,000.

Sales and Marketing Expenses. Sales and marketing expenses increased 142%, or $628,000, principally due to the following: Costs from the acquired businesses of $240,000, compensation increased by $277,000, travel costs increased by $35,000 and stock-based compensation increased by $18,000 due to higher headcount.

Interest Income (Expense)

Net interest expense decreased 95%, or $336,000, principally due to the repayment of $3.5 million of indebtedness in August 2013.

Change in Fair Value of Warrant Liability

The change in the fair value of our warrant liability resulted in $129,000 in non-cash income for the three months ended September 30, 2014, as compared with non-cash expense of $1,033,000 for the three months ended September 30, 2013. The fair market value of certain of our outstanding common stock warrants, that we are required to account for as liabilities, are revalued each quarter at amounts that correspond with changes in the value of our common stock.

Concurrent with the IPO date of April 10, 2013, derivative warrants with a fair value of $7.2 million were reclassified into equity due to the lapsing of anti-dilution provisions in the warrants and also resulted from a shareholder, John Pappajohn, limiting certain anti-dilution rights in his warrants to purchase shares of the Company’s common stock. Since the re-classification, future changes in the value of these particular warrants are no longer required to be recorded in our financial statements. Also since the re-classification, there are significantly less warrants that are subject to revaluation each quarter. During the three months ended September 30, 2014, the fair market value of the 75,215 remaining common stock warrants that are subject to revaluation decreased as a consequence of a decrease in our stock price and resulted in $129,000 of non-cash income during this period.

During the three months ended September 30, 2013, the fair market value of these common stock warrants increased as a consequence of an increase in our assumed stock price and resulted in $1,033,000 of non-cash expense during this period.

Nine Months Ended September 30, 2014 and 2013

The following table sets forth certain information concerning our results of operations for the periods shown: 

33


 
Nine Months Ended September 30,
 
Change
(dollars in thousands)
2014
 
2013
 
$
 
%
Revenue
$
6,164

 
$
4,755

 
$
1,409

 
30
 %
Cost of revenues
5,359

 
3,560

 
1,799

 
51
 %
Research and development expenses
3,093

 
1,384

 
1,709

 
123
 %
General and administrative expenses
8,231

 
4,259

 
3,972

 
93
 %
Sales and marketing expenses
2,738

 
1,275

 
1,463

 
115
 %
Total operating loss
(13,257
)
 
(5,723
)
 
(7,534
)
 
132
 %
Interest income (expense)
(351
)
 
(2,035
)
 
1,684

 
(83
)%
Debt conversion costs

 
(6,850
)
 
6,850

 
(100
)%
Change in fair value of warrant liability
324

 
4,096

 
(3,772
)
 
(92
)%
(Loss) before income taxes
(13,284
)
 
(10,512
)
 
(2,772
)
 
26
 %
Income tax (benefit) expense
(1,814
)
 
(664
)
 
(1,150
)
 
173
 %
Net (loss)
$
(11,470
)
 
$
(9,848
)
 
$
(1,622
)
 
16
 %

Revenue

Revenue for Biopharma Services are services and tests provided to pharmaceutical companies and clinical research organizations in connection with studies for product development. Clinical Services are tests performed for patients at the request of a prescribing physician. These tests can be billed to Medicare, another third party insurer or the referring community hospital or other healthcare facility. Discovery Services are services provided in the development of new testing assays and methods. Grants includes revenue from grants (2013 only). The breakdown of our revenue is as follows:
 
Nine Months Ended September 30,
 
Change
 
2014
 
2013
 
 
 
 
(dollars in thousands)
$
 
%
 
$
 
%
 
$
 
%
Biopharma Services
$
2,831

 
46
%
 
$
1,920

 
40
%
 
$
911

 
47
 %
Clinical Services
3,280

 
53
%
 
2,735

 
58
%
 
545

 
20
 %
Discovery Services
53

 
1
%
 

 
%
 
53

 
 %
Grants

 
%
 
100

 
2
%
 
(100
)
 
(100
)%
Total Revenue
$
6,164

 
100
%
 
$
4,755

 
100
%
 
$
1,409

 
30
 %

Revenue increased 30%, or $1,409,000 principally due to the acquisitions of Gentris and BioServe whose revenues accounted for $1,384,000 of the increase. Increases in Clinical Services test volumes were partially offset by lower volumes in our pre-acquisition Biopharma services business. Our total clinical test volume increased 30% to 6,740 from 5,168 in the prior year. Our average revenue per clinical services test (excluding revenue from our acquisitions, grant revenue and probe revenue) decreased by 7% to $467 per test, from $502 per test in the prior year principally due to a decrease in the average revenue per test attributable to the mix of tests ordered. Our average revenue per test is dependent on the mix of tests and customers and can vary. Many factors could cause average per test to decline including if direct bill clients continue to account for a larger part of our business and increased volumes of our proprietary FHACT® test for cervical cancer (which has a lower average selling price).

Cost of Revenues

Cost of revenues increased 51%, or $1,799,000, principally due to the following: Costs of revenue from the acquired businesses of $942,000, lab supplies expense increased by $363,000, shipping costs increased by $144,000 due to increase in test volumes, compensation costs increased by $195,000, outsourcing services increased by $35,000, and stock-based compensation increased by $37,000.

Operating Expenses

Research and Development Expenses. Research and development expenses increased 123%, or $1,709,000, principally due to the following: Our share of the loss from OncoSpire, our joint venture with Mayo Clinic, of of $660,000 as it incurs research expenses related to the pursuit of developing new clinical tests. Compensation costs increased by $592,000, stock-based compensation increased by $216,000, and Research and Development supplies costs increased by $177,000 due to higher activity.

34



General and Administrative Expenses. General and administrative expenses increased 93%, or $4.0 million, principally due to the following: Costs from the acquired businesses of $515,000, stock-based compensation increased by $1.4 million, compensation increased by 566,000, consulting and outsourced services increased by $274,000, costs associated with being a public company increased by $1.0 million, legal fees increased by $332,000, recruiting fee costs increased by $122,000 and travel costs increased by $212,000. These increased costs were partially off-set by the write-off of $618,000 of deferred IPO costs in 2013.

Sales and Marketing Expenses. Sales and marketing expenses increased 115%, or $1,463,000, principally due to the following: Costs from the acquired businesses of $240,000, compensation costs increased by $907,000, attributed to an increase in parent company headcount, marketing material costs increased by $127,000, stock-based compensation increased by $60,000, and travel costs increased by $116,000 due to higher sales headcount.

Interest Income (Expense)

Net interest expense decreased 83%, or $1.7 million, principally due to the conversion of $9.6 million of debt into common stock which occurred concurrently with our IPO on April 10, 2013 and the repayment of $3.5 million of indebtedness in August 2013.

Debt Conversion Costs

On April 10, 2013, we completed our IPO. In connection with the IPO, $9.6 million of debt was converted into common stock at the IPO price of $10.00 per share. In connection with the conversion of debt into common stock, we expensed the applicable remaining debt discounts of $3.5 million, financing fees of $419,000 and a contingently recognizable beneficial conversion feature in the converted debt of $3.0 million, the total of which resulted in a $6.9 million write-off.

Change in Fair Value of Warrant Liability

The change in the fair value of our warrant liability resulted in $324,000 in non-cash income for the nine months ended September 30, 2014, as compared with non-cash income of $4.1 million for the nine months ended September 30, 2013. The fair market value of certain of our outstanding common stock warrants, that we are required to account for as liabilities, are revalued each quarter at amounts that correspond with changes in the value of our common stock.

Concurrent with the IPO date of April 10, 2013, derivative warrants with a fair value of $7.2 million were reclassified into equity due to the lapsing of anti-dilution provisions in the warrants and also resulted from a shareholder, John Pappajohn, limiting certain anti-dilution rights in his warrants to purchase shares of the Company’s common stock. Since the re-classification, future changes in the value of these particular warrants are no longer required to be recorded in our financial statements. Also since the re-classification, there are significantly less warrants that are subject to revaluation each quarter. As of September 30, 2014, the fair market value of the 75,215 remaining common stock warrants are subject to revaluation.

During the nine months ended September 30, 2013, the fair market value of these common stock warrants decreased as a consequence of a decrease in our assumed stock price and resulted in $4.1 million of non-cash income during that period.

Income Taxes

During the nine months ended September 30, 2014 and 2013, we received $1.8 million and $664,000, respectively, in cash from the sale of certain state NOL carryforwards.

Liquidity and Capital Resources

Sources of Liquidity

Our primary sources of liquidity have been funds generated from our debt financings and equity financings. In addition, we have generated funds from the following sources: (i) cash collections from customers; (ii) cash received from sale of state NOL’s; and (iii) grants from the National Institutes of Health.

During January 2014, we received $1.8 million in cash from sales of state NOL’s.


35


In general, our primary uses of cash are providing for working capital purposes (which principally represent payroll costs, the purchase of supplies, rent expense and insurance costs) and servicing debt. As of September 30, 2014, we have maximized our borrowings under our revolving credit line of $6.0 million. Our largest source of operating cash flow is cash collections from our customers.

Cash Flows

Our net cash flow from operating, investing and financing activities for the periods below were as follows:
 
Nine Months Ended 
 September 30,
(in thousands)
2014
 
2013
Cash provided by (used in):
 
 
 
Operating activities
$
(7,910
)
 
$
(6,601
)
Investing activities
(10,909
)
 
(176
)
Financing activities
108

 
15,835

Net (decrease) increase in cash and cash equivalents
$
(18,711
)
 
$
9,058


We had cash and cash equivalents of $30.7 million at September 30, 2014, and $49.5 million at December 31, 2013.

The $18.7 million decrease in cash and cash equivalents for the nine months ended September 30, 2014, principally resulted from an increase in our restricted cash of $6.0 million related to the collateralization of our line of credit with Wells Fargo and $7.9 million of net cash used in operations, $3.0 million used in the acquisition of Gentris and an additional investment of $1.0 million in our joint venture with the Mayo Foundation.

The $9.1 million increase in cash and cash equivalents for the nine months ended September 30, 2013, was principally the result of the receipt of $5.0 million in net proceeds received in our IPO on April 10, 2013 and $14.2 million received in our secondary offering on August 19, 2013 offset by $6.6 million of net cash used in operations and payment of notes of $3.6 million.

At September 30, 2014, we had total indebtedness of $6.0 million, excluding capital lease obligations

Cash Used in Operating Activities

Net cash used in operating activities was $7.9 million for the nine months ended September 30, 2014. We used $10.0 million in net cash to fund our core operations, which included $93,000 in cash paid for interest. We incurred additional uses of cash when adjusting for working capital items as follows: a net increase in accounts receivable of $521,000; an increase in other current assets of $161,000 which includes prepayments for our insurance policies; and a net decrease in accounts payable, accrued expenses (including the payout of 2013 accrued performance bonuses) and deferred revenue of $986,000. All of these uses of cash were partially offset by the receipt of $1.8 million from the sale of certain state NOL carryforwards in January 2014.

Net cash used in operating activities was $6.6 million for the nine months ended September 30, 2013. We used $6.2 million in net cash to run our core operations, which included $571,000 in cash paid for interest. We incurred additional uses of cash as follows: $1,255,000 for a net decrease in accounts payable, accrued expenses and deferred revenue; $224,000 to increase other current assets which included prepayments for our insurance policies as well as prepayments for consumables and other supplies used to run our operations, and; accounts receivable increased by $766,000. All of these uses of cash were partially offset by the receipt of $664,000 from the sale of certain state NOL carryforwards in January 2013.

Cash Used in Investing Activities

Net cash used in investing activities was $10.9 million for the nine months ended September 30, 2014 and principally resulted from an increase in our restricted cash of $6.0 million related to the collateralization of our line of credit with Wells Fargo and $3.0 million used in the acquisition of Gentris, $1.0 million in our Joint Venture with the Mayo Foundation and the purchase of fixed assets of $944,000.


36


Net cash used in investing activities was $176,000 for the nine months ended September 30, 2013 and principally resulted from: an increase in our restricted cash related to a $50,000 increase in the Letter of Credit related to our lease; purchases of fixed assets of $73,000; and $53,000 in patent application costs.

Cash Provided by Financing Activities

Net cash provided by financing activities was $108,000 for the nine months ended September 30, 2014, and principally resulted from proceeds received from warrant and option exercises of $257,000 offset by payments made on notes payable and capital leases of $127,000.

Net cash provided by financing activities was $15.8 million for the nine months ended September 30, 2013, and primarily consisted of receipt of the proceeds raised in our IPO offset by the payment of $1.9 million in offering costs, including $637,000 in underwriting discounts, expenses and commissions and the payment of notes of $3.6 million.

Capital Resources and Expenditure Requirements

We expect to continue to incur substantial operating losses in the future. It may take several years, if ever, to achieve positive operational cash flow. Until we can generate a sufficient amount of revenue to finance our cash requirements, which we may never do, we may need to continue to raise additional capital to fund our operations.

We also expect to use significant cash to fund acquisitions. On July 16, 2014, we purchased substantially all of the assets of Gentris Corporation, a Delaware corporation (“Gentris”), with its principal place of business in North Carolina.

The total consideration recorded for the Gentris acquisition is as follows:
 
Amount
Cash paid at closing
$
3,250,000

Issuance of 147,843 common shares
1,271,745

Estimated fair value of contingent consideration
283,000

Total Purchase Price
$
4,804,745


On August 18, 2014 we acquired BioServe BioTechnologies (India) Private Limited, an Indian corporation (“BioServe”) for an aggregate purchase price of approximately $1.1 million.

BioServe is a leading genomic service and next-generation sequencing company serving both the research and clinical markets and based in Hyderabad, India. With the BioServe acquisition we believe we will be able to access the Indian healthcare market. See Note 1 to the financial statements for additional information regarding the BioServe acquisition.

The total consideration recorded for the BioServe acquisition is as follows:
 
Amount
Cash paid at closing
$
72,907

Notes payable due 12-18 months after closing
23,708

Notes payable (value of 84,278 common shares)
733,387

Issuance of 31,370 common shares
244,247

Total Purchase Price
$