RISK FACTORS

The combined company will be faced with a market environment that cannot be predicted and that involves significant risks, many of which will be beyond its control. In addition to the other information contained in this proxy statement/prospectus/information statement, you should carefully consider the material risks described below before deciding how to vote your shares of stock. In addition, you should read and consider the risks associated with the business of Constellation because these risks may also affect the combined company – these risks can be found in Constellation’s Annual Report on Form 10-K, as updated by subsequent Quarterly Reports on Form 10-Q, all of which are filed with the SEC. You should also read and consider the other information in this proxy statement/prospectus/information statement and the other documents incorporated by reference into this proxy statement/prospectus/information statement. Please see the section entitled “Where You Can Find More Information” in this proxy statement/prospectus/information statement.

Risks Related to DermTech’s Business

Risks Relating to DermTech’s Financial Condition and Capital Requirements

DermTech is an emerging growth company with a history of net losses; DermTech expects to incur net losses in the future, and may never achieve sustained profitability.

DermTech has historically incurred substantial net losses, including net losses of $8.4 million in 2017 and $10.0 million in 2018; and DermTech has never been profitable. As of December 31, 2018, DermTech’s accumulated deficit is $71.4 million.

DermTech expects its losses to continue as a result of costs relating to ongoing research and development expenses, for increased sales and marketing costs for existing and planned products. These losses have had, and will continue to have, an adverse effect on DermTech’s working capital, total assets, and stockholders’ equity. Because of the numerous risks and uncertainties associated with its commercialization efforts, DermTech is unable to predict when it will become profitable, and it may never become profitable. Even if DermTech does achieve profitability, it may not be able to sustain or increase profitability on a quarterly or annual basis. DermTech’s inability to achieve and then maintain profitability would negatively affect DermTech’s business, financial condition, results of operations, and cash flows.

DermTech’s independent registered public accounting firm’s report for the year ended December 31, 2017 and 2018 includes an explanatory paragraph regarding substantial doubt about DermTech’s ability to continue as a going concern.

Due to the deficit that DermTech has accumulated since its inception, in their report on DermTech’s audited annual financial statements as of and for the year ended December 31, 2017 and 2018, DermTech’s auditors included an explanatory paragraph regarding concerns about DermTech’s ability to continue as a going concern. Recurring losses from operations raise substantial doubt about DermTech’s ability to continue as a going concern. If DermTech is unable to obtain sufficient funding at acceptable terms, it may be forced to significantly curtail its operations, and the lack of sufficient funding may have a material adverse impact on DermTech’s ability to continue as a going concern. If DermTech is unable to continue as a going concern, it might have to liquidate its assets and the values DermTech receives for its assets in liquidation or dissolution could be significantly lower than the values reflected in DermTech’s financial statements. In addition, the inclusion of an explanatory paragraph regarding substantial doubt about DermTech’s ability to continue as a going concern and its lack of cash resources may materially adversely affect DermTech’s share price and its ability to raise new capital or to enter into critical contractual relations with third parties.

 

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DermTech has a limited operating history and it expects a number of factors to cause its operating results to fluctuate on a quarterly and annual basis, which may make DermTech’s future performance difficult to predict.

DermTech is an emerging molecular diagnostics company with a limited operating history. DermTech’s operations to date have been primarily focused on developing and market testing DermTech’s technology. DermTech has not obtained regulatory approvals for any of its tests as it operates under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, guidelines. Consequently, if regulatory approval is determined to be necessary, any predictions made about DermTech’s future success or viability may not be as accurate as they could be if DermTech had a longer operating history or more commercialized products. DermTech’s financial condition and operating results have varied significantly in the past and will continue to fluctuate from quarter-to-quarter or year-to-year due to a variety of factors, many of which are beyond DermTech’s control. Factors relating to DermTech’s business that may contribute to these fluctuations include other factors described elsewhere in this proxy statement/prospectus/information statement and also include:

 

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DermTech’s ability to obtain additional funding to develop and market its products and tests;

 

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the market adoption and demand for DermTech’s tests;

 

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the existence of favorable or unfavorable clinical guidelines for DermTech’s test;

 

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the reimbursement of DermTech’s tests by Medicare and private payers;

 

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DermTech’s ability to obtain and maintain any necessary regulatory approval for any of its tests in the United States and foreign jurisdictions;

 

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potential side effects of DermTech’s tests that could delay or prevent commercialization, limit the indications for any of DermTech’s tests, require the establishment of risk evaluation and mitigation strategies, or cause any of DermTech’s commercialized tests to be taken off the market;

 

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DermTech’s dependence on third-party suppliers and manufacturers, to supply or manufacture DermTech’s products;

 

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DermTech’s ability to establish or maintain collaborations, licensing, or other arrangements;

 

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DermTech’s ability to maintain and grow an effective sales and marketing infrastructure, either through the expansion of DermTech’s commercial infrastructure or through strategic collaborations;

 

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competition from existing products or new products that may emerge;

 

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the ability of patients or healthcare providers to obtain coverage of or sufficient reimbursement for DermTech’s products;

 

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DermTech’s ability to leverage its proprietary technology platform to discover and develop additional product candidates;

 

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DermTech’s ability to successfully obtain, maintain, defend, and enforce intellectual property rights important to DermTech’s business;

 

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DermTech’s ability to attract and retain key personnel to manage its business effectively;

 

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DermTech’s ability to build its finance infrastructure and improve its accounting systems and controls;

 

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potential product liability claims;

 

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potential liabilities associated with hazardous materials; and

 

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DermTech’s ability to obtain and maintain adequate insurance policies.

Accordingly, the results of any quarterly or annual periods should not be relied upon as indications of future operating performance.

 

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DermTech’s commercial success could be compromised if customers do not pay its invoices or if third-party payers, including managed care organizations and Medicare, do not provide coverage and reimbursement, breach, rescind, or modify their contracts or reimbursement policies, reimburse at a low rate, or delay payments for DermTech’s current tests and its planned future tests.

Physicians, including dermatologists, may not order DermTech’s current Pigmented Lesion Assay, or PLA, or DermTech’s Nevome test, or DermTech’s planned tests unless third-party payers, such as managed care organizations and government payers (e.g., Medicare and Medicaid), pay a substantial portion of the test price. Coverage and reimbursement by a third-party payer may depend on a number of factors, including a payer’s determination that tests using DermTech technologies are:

 

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not experimental or investigational;

 

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medically necessary;

 

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appropriate for the specific patient;

 

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cost-effective;

 

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supported by peer-reviewed publications; and

 

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included in clinical practice guidelines.

Uncertainty surrounds third-party payer reimbursement of any test incorporating new technology, including tests developed using DermTech’s technologies. Technology assessments of new medical tests conducted by research centers and other entities may be disseminated to interested parties for informational purposes. Third-party payers and health care providers may use such technology assessments as grounds to deny coverage for a test or procedure. Technology assessments can include evaluation of clinical utility studies, which define how a test is used in a particular clinical setting or situation. DermTech filed an application for a technology assessment in April of 2018, and the comment period for the accompanying Medicare Draft Local Coverage Decision, or Draft LCD, closed in August of 2018. In March 2019, a Draft LCD proposed coverage for the PLA. A Medicare Final Coverage Decision, or Final LCD, could be available in the second half of 2019. If the Final LCD maintains the coverage proposal in the Draft LCD, the PLA will be eligible for Medicare reimbursement. If the Final LCD reverses the coverage proposal in the Draft LCD, DermTech’s business will be significantly impacted due to lack of Medicare coverage. In addition, after submission of the technology assessment in April of 2018, DermTech is prohibited from submitting claims to Medicare. Therefore, although DermTech previously submitted claims to Medicare which were reviewed on a case-by-case basis, DermTech no longer has any Medicare revenue stream pending the outcome of the technology assessment and the finalization of a Local Coverage Decision. Currently the Nevome test does not have Medicare reimbursement.

Because each payer generally determines for its own enrollees or insured patients whether to cover or otherwise establish a policy to reimburse DermTech’s tests, seeking payer approvals is a time-consuming and costly process. DermTech cannot be certain that coverage for DermTech’s current tests and DermTech’s planned future tests will be provided in the future by additional third-party payers or that existing policy decisions, or reimbursement levels will remain in place or be fulfilled under existing terms and provisions. In addition, the coding procedure used by all third-party payers with respect to establishing payment rates for various procedures, including DermTech’s tests, is complex, does not currently adapt well to the genetic tests DermTech performs and may not enable coverage and adequate reimbursement rates for DermTech’s tests. If DermTech cannot obtain coverage and reimbursement from private and governmental payers such as Medicare and Medicaid for DermTech’s current tests, or new tests or test enhancements that it may develop in the future, DermTech’s ability to generate revenues could be limited, which may have a material adverse effect on its financial condition, results of operations, and cash flows. Measures have been undertaken to reduce payment rates for and decrease utilization of the clinical laboratory testing generally, including the Protecting Access to Medicare Act of 2014, or PAMA, which has resulted in reduced rates on the Medicare Clinical Laboratory Fee Schedule, or CLFS. These reductions may also impact DermTech’s PLA and Nevome tests and may also impact tests DermTech

 

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develops in the future. Because of the cost-trimming trends, third-party payers that cover and provide reimbursement for DermTech’s tests and its planned tests may suspend, revoke, or discontinue coverage at any time, or may reduce the reimbursement rates payable to DermTech. Any such action could have a negative impact on DermTech’s revenues, which may have a material adverse effect on its financial condition, results of operations, and cash flows. Additionally, if DermTech is not able to obtain sufficient clinical information in support of its tests, third-party payers could designate its tests as experimental or investigational and decline to cover and reimburse its tests because of this designation. As a result of these factors, obtaining approvals from third-party payers to cover DermTech’s tests and establishing adequate reimbursement levels is an unpredictable, challenging, time-consuming, and costly process, and DermTech may never be successful. Further, DermTech has experienced in the past, and will likely experience in the future, delays and interruptions in the receipt of payments from third-party payers due to missing documentation and/or other issues, which could cause delay in collecting DermTech’s revenue.

Additionally, DermTech is currently considered a “non-contracted provider” or “out of network” by most private third-party payers because DermTech has not entered into a specific contract to provide tests to their insured patients at specified rates of reimbursement. If DermTech were to become a contracted provider with one or more payers in the future, the amount of overall reimbursement DermTech receives would likely decrease because it could be reimbursed less money per test performed at a contracted rate than at a non-contracted rate, which could have a negative impact on DermTech’s revenues. Further, DermTech typically is unable to collect substantial payments from patients beyond that which is paid by their insurance and therefore experiences overall loss to revenue as a result.

Billing and collections processing for DermTech’s tests is complex and time-consuming, and any delay in transmitting and collecting claims could have an adverse effect on DermTech’s revenue.

Billing for DermTech’s tests is complex, time-consuming, and expensive. Depending on the billing arrangement and applicable law, DermTech bills, or plans to bill, various different parties for its tests, including Medicare, Medicaid, insurance companies, and patients, all of which may have different billing requirements. DermTech may face increased risk in its collection efforts due to the complexities of these billing requirements, including long collection cycles and lower collection rates, which could adversely affect DermTech’s business, results of operations and financial condition.

Several factors make the billing process complex, including:

 

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differences between the list price for DermTech’s tests and the reimbursement rates of payers;

 

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compliance with complex federal and state regulations related to billing government healthcare programs, including Medicare and Medicaid;

 

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disputes among payers as to which party is responsible for payment;

 

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differences in coverage among payers and the effect of patient co-payments or co-insurance;

 

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differences in information and billing requirements among payers;

 

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incorrect or missing billing information; and

 

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the resources required to manage the billing and claims appeals process.

DermTech is developing internal systems and procedures to handle these billing and collections functions and has engaged third parties to assist with some of these functions, but DermTech will need to make significant efforts and expend substantial resources to further develop its systems and procedures to handle these aspects of its business. As a result, these billing complexities, along with the related uncertainty in obtaining payment for DermTech’s tests, could negatively affect DermTech’s revenue and cash flow, DermTech’s ability to achieve or sustain profitability, and the consistency and comparability of DermTech’s results of operations. In addition, if

 

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claims for DermTech’s tests are not submitted to payers on a timely basis, or if DermTech is required to switch to a different provider to handle DermTech’s processing and collections functions, DermTech’s revenue and business could be adversely affected.

DermTech will need to raise additional capital to fund its existing operations, commercialize its products, and expand its operations.

As of December 31, 2018, DermTech’s cash and cash equivalents totaled approximately $4.7 million. Based on DermTech’s current business operations, DermTech believes the net proceeds from this offering, together with its current cash and cash equivalents, will be sufficient to meet its anticipated cash requirements for the 18-month period following this offering. If DermTech’s available cash balances, net proceeds from this offering, and anticipated cash flow from operations are insufficient to satisfy DermTech’s liquidity requirements including due to changes in DermTech’s business operations, a lengthier sales cycle, lower demand for its products, or other risks described in this proxy statement/prospectus/information statement, DermTech may seek to raise additional capital through equity offerings, debt financings, collaborations, or licensing arrangements. DermTech may also consider raising additional capital in the future to expand its business, to pursue strategic investments, to take advantage of financing opportunities, or for other reasons, including to:

 

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increase DermTech’s efforts to drive market adoption of its tests and address competitive developments;

 

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fund development activities and efforts of any future products;

 

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acquire, license, or invest in technologies;

 

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acquire or invest in complementary businesses or assets; and

 

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finance capital expenditures and general and administrative expenses.

DermTech’s present and future funding requirements will depend on many factors, including:

 

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DermTech’s revenue growth rate and ability to generate cash flows from operating activities;

 

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DermTech’s sales and marketing and research and development activities;

 

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effects of competing technological and market developments;

 

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costs of and potential delays in product development;

 

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changes in regulatory oversight applicable to DermTech’s tests; and

 

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costs related to international expansion.

The various ways DermTech could raise additional capital carry potential risks. If DermTech raises funds by issuing equity securities, dilution to its stockholders could result. Any equity securities issued also could provide for rights, preferences, or privileges senior to those of holders of DermTech’s common stock. If DermTech raises funds by issuing debt securities, those debt securities would have rights, preferences, and privileges senior to those of holders of DermTech’s common stock. The terms of debt securities issued or borrowings pursuant to a credit agreement could impose significant restrictions on DermTech’s operations. If DermTech raises funds through collaborations and licensing arrangements, DermTech might be required to relinquish significant rights to its platform technologies or products, or grant licenses on terms that are not favorable to DermTech. Additional equity or debt financing might not be available on reasonable terms, if at all. If DermTech cannot secure additional funding when needed, DermTech may have to delay, reduce the scope of, or eliminate one or more research and development programs or sales and marketing initiatives. In addition, DermTech may have to work with a partner on one or more of DermTech’s development programs, which could lower the economic value of those programs to DermTech.

 

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DermTech will also need to raise additional capital to expand its business to meet its long-term business objectives. Additional financing may be from the sale of equity or convertible or other debt securities in a public or private offering, from a credit facility or strategic partnership coupled with an investment in DermTech, or a combination of both. For further discussion of DermTech’s liquidity requirements as they relate to DermTech’s long-term plans, see the section entitled “ DermTech Management’s Discussion and Analysis of Financial Condition and Results of Operations – Fiscal Years Ending December  31, 2017 and 2018 – Liquidity and Capital Resources .”

If physicians, including dermatologists, decide not to order the PLA, the Nevome test, or DermTech’s future tests, DermTech may be unable to generate sufficient revenue to sustain its business.

To generate demand for DermTech’s current tests and DermTech’s planned tests, DermTech will need to educate dermatologists and other health care professionals on the clinical utility, benefits, and value of the tests DermTech provides through published papers, presentations at scientific conferences, educational programs, and one-on-one education sessions by members of DermTech’s sales force. In addition, DermTech needs to assure dermatologists of their ability to obtain and maintain adequate reimbursement coverage from third-party payers for the adhesive patch sample collection method. Medical professionals are influenced by standard setting bodies that influence and/or dictate the standard of care. If DermTech is not successful in changing current guidelines from legacy standards to new molecular-based approaches DermTech’s market adoption will suffer. If DermTech cannot convince medical practitioners to order its current tests and DermTech’s planned tests, DermTech will likely be unable to create demand in sufficient volume for DermTech to achieve sustained profitability or meet its anticipated revenue projections.

DermTech expects to continue to incur significant expenses to develop and market its tests, which could make it difficult for DermTech to achieve and sustain profitability.

In recent years, DermTech has incurred significant costs in connection with the development of its tests. For the year ended December 31, 2017, DermTech’s research and development expenses were $2.0 million, its sales and marketing expenses were $2.9 million and its general and administrative expenses were $2.6 million. For the year ended December 31, 2018, DermTech’s research and development expenses were $2.1 million, its sales and marketing expenses were $2.8 million and its general and administrative expenses were $3.5 million. DermTech expects its expenses to continue to increase for the foreseeable future as DermTech conducts studies of its current tests and its planned other tests, grows its sales and marketing organization, drives adoption of and reimbursement for its tests, and develops new tests. As a result, DermTech needs to generate significant revenues in order to achieve sustained profitability.

DermTech may not be able to generate sufficient revenue from the commercialization of its PLA, Nevome test, or successfully develop and commercialize other tests to achieve or sustain profitability or meet its anticipated revenue projections.

DermTech launched PLA assay during the first half of 2016. DermTech launched the Nevome test in 2018. DermTech is in varying stages of research and development for other tests that DermTech may offer in the future. DermTech believes that its commercialization success is dependent upon its ability to significantly increase the number of customers that are using DermTech’s tests. In addition, demand for DermTech’s tests may not increase as quickly as planned and DermTech may be unable to increase its revenue levels as expected. DermTech is currently not profitable. Even if DermTech succeeds in increasing adoption of PLA or the Nevome test by dermatologists, in maintaining and creating relationships with DermTech’s existing and new customers, and developing and commercializing additional molecular diagnostic testing products, DermTech may not be able to generate sufficient revenue to achieve or sustain profitability or meet its anticipated revenue projections.

If DermTech is unable to execute its marketing strategy for PLA or the Nevome test and are unable to gain acceptance in the market, DermTech may be unable to generate sufficient revenue to sustain its business.

Although DermTech believes that its current tests and planned future tests represent a promising commercial opportunity, DermTech’s tests may never gain significant acceptance in the marketplace and therefore may never

 

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generate substantial revenue or profits for DermTech. DermTech will need to establish a market for its tests and build that market through physician education, awareness programs, and the publication of clinical trial results. Gaining acceptance in medical communities requires publication in leading peer-reviewed journals of results from studies using DermTech’s current tests and/or its planned future tests. The process of publication in leading medical journals is subject to a peer-review process and peer-reviewers may not consider the results of DermTech’s studies sufficiently novel or worthy of publication. Failure to have DermTech’s studies published in peer-reviewed journals would limit the adoption of DermTech’s current tests and its planned tests.

DermTech’s ability to successfully market the tests that it develops will depend on numerous factors, including:

 

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conducting clinical utility studies of such tests in collaboration with key thought leaders to demonstrate their use and value in important medical decisions such as treatment selection;

 

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the success of DermTech’s sales force;

 

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whether healthcare providers believe such tests provide clinical utility;

 

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whether the medical community accepts that such tests are sufficiently sensitive and specific to be meaningful in patient care and treatment decisions; and

 

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whether health insurers, government health programs, and other third-party payers will cover and pay for such tests and, if so, whether they will adequately reimburse DermTech.

Failure to achieve widespread market acceptance of DermTech’s current tests and its planned future tests would materially harm DermTech’s business, financial condition, and results of operations.

If DermTech cannot develop tests to keep pace with rapid advances in technology, medicine and science, DermTech’s operating results and competitive position could be harmed.

In recent years, there have been numerous advances in technologies relating to the molecular diagnosis for cancer and other medical conditions. Several new cancer drugs have been approved, including several for melanoma, and a number of new drugs in clinical development may increase patient survival time. There have also been advances in methods used to identify patients likely to benefit from these drugs based on analysis of biomarkers. DermTech must continuously develop new tests and enhance any existing tests to keep pace with evolving standards of care. DermTech’s current tests and its planned tests could become obsolete unless DermTech continually innovates and expands them to demonstrate benefit in the diagnosis, monitoring, or prognosis of patients with cancer and other dermatologic conditions. If DermTech cannot adequately demonstrate the applicability of DermTech’s current tests and its planned future tests to new diagnostic and treatment developments, sales of DermTech’s tests could decline, which would have a material adverse effect on its business, financial condition, and results of operations.

DermTech’s future success will depend in part upon its ability to enhance its PLA, the Nevome test, and to develop, introduce, and commercialize other novel innovative and non-invasive diagnostics tests and services. New test development involves a lengthy and complex process and DermTech may be unable to commercialize new or improved tests or any other products DermTech may develop on a timely basis, or at all.

DermTech’s future success will depend in part upon its ability to enhance PLA, the Nevome test, and to develop new innovative products. DermTech’s failure to successfully develop new products on a timely basis could have a material adverse effect on its revenue, results of operations, and business.

The development of new or enhanced tests is a complex and uncertain process requiring precise technological execution. In addition, the successful development of new products may depend on the development of new technologies. DermTech may be required to undertake time-consuming and costly development activities. DermTech may experience difficulties that could delay or prevent the successful development,

 

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commercialization, and marketing of these new products. Before DermTech can commercialize any new products, it will need to expend significant funds in order to conduct substantial research and development, including validation studies.

DermTech’s product development process involves a high degree of risk, and product development efforts may fail for many reasons, including a failure to demonstrate the performance of the product or an inability to obtain any required certification or regulatory approval.

As DermTech develops products, it will have to make significant investments in product development, as well as sales and marketing resources. In addition, competitors may develop and commercialize competing products faster than DermTech is able to do so, which could have a material adverse effect on DermTech’s revenue, results of operations and business.

DermTech relies on a limited number of suppliers and, in some cases, a sole supplier, for certain of its laboratory substances, equipment and other materials, and any delays or difficulties securing these materials could disrupt DermTech’s laboratory operations and materially harm its business.

DermTech relies on a limited number of suppliers for certain of its laboratory substances, including reagents, as well as for the sequencers and various other equipment and materials DermTech uses in its laboratory operations. In particular, DermTech relies on Fischer Scientific and VWR for supplies and Adhesive Research for its adhesive tape material. DermTech does not have long-term agreements with any of its suppliers and, as a result, they could cease supplying these materials and equipment to DermTech at any time due to an inability to reach agreement with DermTech on supply terms, disruptions in their operations, a determination to pursue other activities or lines of business, or for other reasons, or they could fail to provide DermTech with sufficient quantities of materials that meet its specifications. Transitioning to a new supplier or locating a temporary substitute, if any are available, would be time-consuming and expensive, could result in interruptions in or otherwise affect the performance specifications of DermTech’s laboratory operations, or could require that DermTech revalidate its tests. In addition, the use of equipment or materials provided by a replacement supplier could require DermTech to alter its laboratory operations and procedures. Moreover, DermTech believes there are currently only a few manufacturers that are capable of supplying and servicing some of the equipment and other materials necessary for DermTech’s laboratory operations, including sequencers and various associated reagents. As a result, replacement equipment and materials that meet DermTech’s quality control and performance requirements may not be available on reasonable terms, in a timely manner or at all. If DermTech encounters delays or difficulties securing, reconfiguring or revalidating the equipment, reagents and other materials DermTech requires for its tests, DermTech’s operations could be materially disrupted and its business, financial condition, results of operations, and reputation could be adversely affected.

DermTech’s tests employ a novel diagnostic platform and may never be accepted by their intended markets.

DermTech’s future success depends on its ability to successfully commercialize PLA and Nevome tests, as well as DermTech’s ability to develop and market other tests that use its proprietary technology platform. The scientific discoveries that form the basis of DermTech’s proprietary technology platform and its tests are relatively new. DermTech is not aware of any other gene expression tests such as DermTech’s and there can be no assurance that physicians will be willing to use them. If DermTech does not successfully develop and commercialize its tests based upon its technological approach, DermTech may not become profitable and the value of its common stock may decline.

The novel nature of DermTech’s tests also means that fewer people are trained in or experienced with products of this type, which may make it difficult to find, hire, and retain capable personnel for research, development, and manufacturing positions.

Further, DermTech’s focus solely on gene expression tests, as opposed to multiple, more proven technologies for patient diagnosis, increases the risks associated with the ownership of DermTech’s common stock. If DermTech

 

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does not achieve market acceptance for its tests, DermTech may be required to change the scope and direction of its product development activities. In that case, DermTech may not be able to identify and implement successfully an alternative product development strategy.

If DermTech’s current tests and its planned tests do not to perform as expected, as a result of human error or otherwise, it could have a material adverse effect on DermTech’s operating results, reputation, and business.

DermTech’s success depends on the market’s confidence that it can provide reliable, high-quality diagnostic results. There is no guarantee that any accuracy DermTech has demonstrated to date will continue, particularly as the number of tests using DermTech’s assays increases and as the number of different tests that it develops and commercializes expands. DermTech believes that its customers are likely to be particularly sensitive to test defects and errors. As a result, the failure of DermTech’s current or planned tests to perform as expected could significantly impair DermTech’s reputation and the public image of its tests. As a result, the failure or perceived failure of DermTech’s products to perform as expected could have a material adverse effect on its business, financial condition and results of operation.

DermTech may be unable to manage its future growth effectively, which could make it difficult to execute its business strategy.

As part of its strategy, DermTech expects to increase its number of employees as its business grows. This future growth could create strain on DermTech’s organizational, administrative, and operational infrastructure, including laboratory operations, quality control, customer service, and sales and marketing. DermTech’s ability to manage its growth properly will require it to continue to improve its operational, financial, and management controls, as well as its reporting systems and procedures. If DermTech’s current infrastructure is unable to handle its growth, DermTech may need to further expand its infrastructure and staff and implement new reporting systems. The time and resources required to implement such expansion and systems could adversely affect DermTech’s operations. DermTech’s expected future growth will impose significant added responsibilities on members of management, including the need to identify, recruit, maintain, and integrate additional employees. DermTech’s future financial performance and its ability to commercialize its products and to compete effectively will depend, in part, on DermTech’s ability to manage this potential future growth effectively, without compromising quality.

If DermTech’s sole laboratory facility becomes damaged or inoperable, or DermTech is required to vacate the facility, DermTech’s ability to sell and provide molecular tests and pursue its research and development efforts may be jeopardized.

DermTech does not have any clinical reference laboratory facilities outside of its facility in La Jolla, California. DermTech’s facilities and equipment could be harmed or rendered inoperable by natural or man-made disasters, including fire, earthquake, flooding, and power outages, which may render it difficult or impossible for DermTech to perform its diagnostic tests for some period of time. The inability to perform DermTech’s current tests, its planned tests, or the backlog of tests that could develop if DermTech’s facility is inoperable for even a short period of time may result in the loss of customers or harm to DermTech’s reputation or relationships with scientific or clinical collaborators, and DermTech may be unable to regain those customers or repair its reputation in the future. Furthermore, DermTech’s facilities and the equipment it uses to perform its research and development work could be costly and time-consuming to repair or replace.

The San Diego area has recently experienced serious fires and power outages, and is considered to lie in an area with earthquake risk.

Additionally, a key component of DermTech’s research and development process involves using biological samples as the basis for the development of its diagnostic tests. In some cases, these samples are difficult to obtain. If the parts of DermTech’s laboratory facility where it stores these biological samples were damaged or

 

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compromised, DermTech’s ability to pursue its research and development projects, as well as DermTech’s reputation, could be jeopardized. DermTech carries insurance for damage to its property and the disruption of its business, but this insurance may not be sufficient to cover all of DermTech’s potential losses and may not continue to be available to DermTech on acceptable terms, if at all.

Further, if DermTech’s CLIA certified laboratory became inoperable DermTech may not be able to license or transfer its technology to another facility with the necessary state licensure and CLIA certification under the scope of which DermTech’s current tests and its planned future tests could be performed. Even if DermTech finds a facility with such qualifications to perform DermTech’s tests, it may not be available to DermTech on commercially reasonable terms.

If DermTech cannot compete successfully with its competitors, DermTech may be unable to increase or sustain its revenues or achieve and sustain profitability.

DermTech’s principal competition comes from mainstream clinical diagnostic methods, used by dermatologists for many years, which focus on visual tumor tissue analysis. It may be difficult to change the methods or behavior of dermatologists to incorporate DermTech’s PLA, Nevome test, and Adhesive Skin Sample Collection Kits into their practices in conjunction with, or instead of, tissue biopsies and analysis. In addition, companies offering capital equipment and kits or reagents to local dermatologists represent another source of potential competition. These tests are used directly by the dermatologists, which can facilitate adoption. DermTech plans to focus its marketing and sales efforts on medical dermatologists rather than pathologists.

DermTech also faces competition from companies that offer device products or are conducting research to develop device products for analysis of pigmented lesions. In particular, MELA Sciences, Inc., markets its MelaFind ^® device to dermatologists. Scibase AB and Verisante Technology, Inc. have devices under development and may market their medical products directly to dermatologists if and when they obtain Food and Drug Administration, or FDA, approval. In addition to these companies, DermTech’s competitors also include other device companies selling photographic technologies, whole body photography services, dermatoscopes, or confocal microscopy, such as Fotofinder, Molemate, Canfield Scientific, MedX, and Caliber I.D. Many of these groups, in addition to operating research and development laboratories, are selling equipment and devices.

In addition to these device companies, Myriad Genetics, Inc., offers an expression test for melanoma that is used on surgical biopsy specimens. Myriad Genetics, Inc. could also try and market their test as a biopsy aid at the point-of-care. Gene expression testing is a relatively new area of science, especially in dermatology and DermTech cannot predict what tests others will develop that may compete with or provide results similar or superior to the results DermTech is able to achieve with the tests it develops. There are a number of companies that are focused on the oncology diagnostic market and expression tests including Exact Sciences Corporation, Veracyte, Inc., Genomic Health, Inc. and others.

Additionally, projects related to cancer diagnostics and particularly genomics have received increased government funding, both in the United States and internationally. As more information regarding cancer genomics becomes available to the public, DermTech anticipates that more products aimed at analyzing pigmented lesions and identifying melanoma may be developed and that these products may compete with DermTech’s. In addition, competitors may develop their own versions of DermTech’s current or planned tests in countries where DermTech did not apply for patents or where DermTech’s patents have not issued or have expired and may compete with DermTech in those countries, including encouraging the use of their test by physicians or patients in other countries. In addition, one or more competitors may seek to invalidate or render unenforceable any of DermTech’s patents in a court of competent jurisdiction or at the United States Patent and Trademark Office, or USPTO. If any such proceeding were to be successful and result in the invalidation or unenforceability of one or more patents in DermTech’s intellectual property portfolio, DermTech may be unable to prevent unlicensed third-party competition in the marketplace with respect to DermTech’s current and planned future tests.

 

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Some of DermTech’s present and potential competitors have widespread brand recognition and substantially greater financial and technical resources and development, production, and marketing capabilities than DermTech does. Others may develop lower-priced, less complex tests that payers and dermatologists could view as functionally equivalent to DermTech’s current or planned tests, which could force DermTech to lower the list price of its tests and impact its operating margins and ability to achieve and maintain profitability. In addition, technological innovations that result in the creation of enhanced diagnostic tools that are more sensitive or specific than DermTech’s may enable other clinical laboratories, hospitals, physicians, or medical providers to provide specialized diagnostic tests similar to DermTech’s in a more patient-friendly, efficient, or cost-effective manner than is currently possible. If DermTech cannot compete successfully against current or future competitors, it may be unable to increase or create market acceptance and sales of DermTech’s current or planned tests, which could prevent DermTech from increasing or sustaining its revenues or achieving or sustaining profitability.

DermTech’s competitors may be able to respond more quickly and effectively than DermTech can to new or changing opportunities, technologies, standards, or customer requirements. DermTech anticipates that it will face increased competition in the future as existing companies and competitors develop new or improved products and distribution strategies and as new companies enter the market with new technologies and distribution strategies. DermTech may not be able to compete effectively against these organizations. DermTech’s ability to compete successfully and to increase its market share is dependent upon DermTech’s reputation for providing responsive, professional, and high-quality products and services and achieving strong customer satisfaction. Increased competition in the future could adversely affect DermTech’s revenue, revenue growth rate, if any, margins and market share.

If DermTech is unable to identify collaborators willing to work with it to conduct clinical utility studies, or the results of those studies do not demonstrate that a test provides clinically meaningful information and value, commercial adoption of DermTech’s tests may be slow, which would negatively impact DermTech’s business.

DermTech believes clinical utility studies will show how the PLA and the Nevome test changes the decision-making of the dermatologist toward making a surgical biopsy decision, particularly to avoid making a surgical biopsy when the test is negative. Clinical utility studies also show the impact of the test results on patient care and management. Clinical utility studies are typically performed with collaborating dermatologists at medical centers and hospitals, analogous to a clinical trial, and generally result in peer-reviewed publications.

DermTech is currently conducting a variety of clinical trials for the PLA and Carcinome tests with investigators at multiple sites in the U.S. DermTech will need to conduct additional studies for these tests, as well as other tests DermTech plans to introduce, to drive test adoption in the marketplace and reimbursement. Should DermTech not be able to perform these studies, or should their results not provide clinically meaningful data and value for physicians, including dermatologists and oncologists, adoption of DermTech’s tests could be impaired and it may not be able to obtain reimbursement for them.

DermTech is undergoing a management transition.

DermTech has recently added a new Chief Commercial Officer. DermTech is also recruiting for other senior positions including payer market access and reimbursement. DermTech’s board of directors and management reporting structure may change. Such a management transition subjects DermTech to a number of risks, including risks pertaining to coordination of responsibilities and tasks, creation of new management systems and processes, differences in management style, effects on corporate culture, and the need for transfer of historical knowledge. In addition, DermTech’s operations will be adversely affected if its management does not work together harmoniously, efficiently allocate responsibilities between themselves, or implement and abide by effective controls.

 

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The loss of key members of DermTech’s executive management team could adversely affect its business.

DermTech’s success in implementing its business strategy depends largely on the skills, experience, and performance of key members of its executive management team and others in key management positions, including John Dobak, M.D., DermTech’s Chief Executive Officer and President, Zuxu Yao, Ph.D., DermTech’s Chief Scientific Officer, and Burkhard Jansen, M.D., DermTech’s Chief Medical Officer. The collective efforts of each of these persons and others working with them as a team are critical to DermTech as it continues to develop its technologies, tests, and research and development and sales programs. As a result of the difficulty in locating qualified new management, the loss or incapacity of existing members of DermTech’s executive management team could adversely affect its operations. If DermTech were to lose one or more of these key employees, DermTech could experience difficulties in finding qualified successors, competing effectively, developing its technologies, and implementing its business strategy. DermTech’s Chief Executive Officer and President, Chief Commercial Officer, Chief Medical Officer, and V.P. of Research and Development have employment agreements; however, the existence of an employment agreement does not guarantee retention of members of DermTech’s executive management team and DermTech may not be able to retain those individuals for the duration of or beyond the end of their respective terms. DermTech does not maintain “key person” life insurance on any of its employees.

In addition, DermTech relies on collaborators, consultants, and advisors, including scientific and clinical advisors, to assist DermTech in formulating its research and development and commercialization strategy. DermTech’s collaborators, consultants, and advisors are generally employed by employers other than DermTech and may have commitments under agreements with other entities that may limit their availability to DermTech.

The loss of a key employee, the failure of a key employee to perform in his or her current position, or DermTech’s inability to attract and retain skilled employees could result in DermTech’s inability to continue to grow its business or to implement its business strategy.

There is a scarcity of experienced professionals in DermTech’s industry. If DermTech is not able to retain and recruit personnel with the requisite technical skills, it may be unable to successfully execute its business strategy.

The specialized nature of DermTech’s industry results in an inherent scarcity of experienced personnel in the field. DermTech’s future success depends upon its ability to attract and retain highly skilled personnel, including scientific, technical, laboratory, sales, marketing, business, regulatory, and administrative personnel necessary to support DermTech’s anticipated growth, develop DermTech’s business, and perform certain contractual obligations. Given the scarcity of professionals with the scientific knowledge that DermTech requires and the competition for qualified personnel among life science businesses, DermTech may not succeed in attracting or retaining the personnel it requires to continue and grow DermTech’s operations.

DermTech’s inability to attract, hire, and retain a sufficient number of qualified sales professionals would hamper DermTech’s ability to launch and increase demand for its PLA, to expand geographically, and to successfully commercialize any other tests or products DermTech may develop.

To succeed in selling DermTech’s PLA, and any other tests or products that DermTech is able to develop, DermTech must expand its sales force in the United States and/or internationally by recruiting sales representatives with extensive experience in dermatology and close relationships with medical dermatologists, dermatopathologists, and other hospital personnel. To achieve its marketing and sales goals, DermTech will need to substantially build its sales and commercial infrastructure, with which to date it has had little experience. Sales professionals with the necessary technical and business qualifications are in high demand, and there is a risk that DermTech may be unable to attract, hire, and retain the number of sales professionals with the right qualifications, scientific backgrounds, and relationships with decision-makers and potential customers needed to achieve DermTech’s sales goals. DermTech expects to face competition from other companies in its industry,

 

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some of whom are much larger than DermTech and who can pay greater compensation and benefits than DermTech can, in seeking to attract and retain qualified sales and marketing employees. If DermTech is unable to hire and retain qualified sales and marketing personnel, its business will suffer.

DermTech currently relies on third-party suppliers for critical materials needed to perform DermTech’s current tests and its planned future tests and any problems experienced by them could result in a delay or interruption of their supply to DermTech.

DermTech currently purchases raw materials for its tests and products under purchase orders and does not have long-term contracts with most of the suppliers of these materials. If suppliers were to delay or stop producing DermTech’s materials or reagents, or if the prices they charge DermTech were to increase significantly, or if they elected not to sell to DermTech, DermTech would need to identify other suppliers. DermTech could experience delays in manufacturing or performing its tests while finding another acceptable supplier, which could impact DermTech’s results of operations. The changes could also result in increased costs associated with qualifying the new materials or reagents and in increased operating costs. Further, any prolonged disruption in a supplier’s operations could have a significant negative impact on DermTech’s ability to perform tests in a timely manner.

Some of the components used in DermTech’s current or planned products are currently sole source, and substitutes for these components might not be able to be obtained easily or may require substantial design or manufacturing modifications. Any significant problem experienced by one of DermTech’s sole-source suppliers may result in a delay or interruption in the supply of components to DermTech until that supplier cures the problem or an alternative source of the component is located and qualified. Any delay or interruption would likely lead to a delay or interruption in DermTech’s manufacturing operations. The inclusion of substitute components must meet DermTech’s product specifications and could require DermTech to qualify the new supplier with the appropriate government regulatory authorities. In addition, one or more components used in DermTech’s current, or future planned, products may be patented by a third party and may not have any substantial non-infringing uses, in which case, any inability to secure a license to such components on terms that are commercially reasonable to DermTech may have a material impact on DermTech’s business and render it difficult or impracticable for DermTech to continue to offer its current and future planned tests and products.

DermTech may encounter manufacturing problems or delays that could result in lost revenue.

The Adhesive Skin Sample Collection Kits DermTech distributes are manufactured by a third party supplier. This manufacturer assembles several components, including the key adhesive patch trifold, into a finished product, then labels, stores, and ships this finished product. The adhesive tape subcomponent of the adhesive patches is provided by a single-source third party. This tape is assembled into the individual adhesive patches by another third-party supplier.

DermTech believes it has arranged for adequate manufacturing capacity for the Adhesive Skin Sample Collection Kits through DermTech’s third-party manufacturer. If demand for DermTech’s current tests and its planned future tests increases significantly, DermTech will need to either expand manufacturing capabilities through its third-party manufacturer or outsource to other manufacturers. If DermTech’s third-party or other manufacturers engaged by DermTech fail to manufacture and deliver the Adhesive Skin Sample Collection Kits or certain reagents in a timely manner, DermTech’s relationships with its customers could be seriously harmed. DermTech cannot assure you that manufacturing or quality control problems will not arise as DermTech attempts to increase the production of the Adhesive Skin Sample Collection Kit or that DermTech can increase its manufacturing capabilities and maintain quality control in a timely manner or at commercially reasonable costs. If DermTech cannot have the Adhesive Skin Sample Collection Kits manufactured consistently on a timely basis because of these or other factors, it could have a significant negative impact on DermTech’s ability to perform tests and generate revenues.

 

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If DermTech cannot support demand for its current tests and its planned future tests, including successfully managing the evolution of its technology and manufacturing platforms, DermTech’s business could suffer.

As DermTech’s test volume grows, DermTech will need to increase its testing capacity, implement automation, increase DermTech’s scale and related processing, customer service, billing, collection, and systems process improvements, and expand DermTech’s internal quality assurance program and technology to support testing on a larger scale. DermTech will also need additional technicians, certified laboratory scientists, and other scientific and technical personnel to process these additional tests. Any increases in scale, related improvements and quality assurance may not be successfully implemented and appropriate personnel may not be available. As additional tests are commercialized, DermTech may need to bring new equipment on line, implement new systems, technology, controls and procedures, and hire personnel with different qualifications. Failure to implement necessary procedures or to hire the necessary personnel could result in a higher cost of processing or an inability to meet market demand. DermTech cannot assure you that it will be able to perform tests on a timely basis at a level consistent with demand, that DermTech’s efforts to scale its commercial operations will not negatively affect the quality of its test results or that DermTech will respond successfully to the growing complexity of its testing operations. If DermTech encounters difficulty meeting market demand or quality standards for its current tests and its planned future tests, DermTech’s reputation could be harmed and its future prospects and business could suffer, which may have a material adverse effect on DermTech’s financial condition, results of operations, and cash flows.

If DermTech were sued for product liability or professional liability, it could face substantial liabilities that exceed its resources.

The marketing, sale, and use of DermTech’s current tests and its planned future diagnostic tests could lead to the filing of product liability claims against DermTech if someone alleges that its tests failed to perform as designed. DermTech may also be subject to liability for errors in the test results DermTech provides to physicians or for a misunderstanding of, or inappropriate reliance upon, the information DermTech provides. A product liability or professional liability claim could result in substantial damages and be costly and time-consuming for DermTech to defend.

Although DermTech believes that its existing product and professional liability insurance is adequate, DermTech’s insurance may not fully protect DermTech from the financial impact of defending against product liability or professional liability claims. Any product liability or professional liability claim brought against DermTech, with or without merit, could increase DermTech’s insurance rates or prevent DermTech from securing insurance coverage in the future. Additionally, any product liability lawsuit could damage DermTech’s reputation, result in the recall of tests, or cause current partners to terminate existing agreements and potential partners to seek other partners, any of which could impact DermTech’s results of operations.

If DermTech uses biological and hazardous materials in a manner that causes injury or violates laws or regulations, DermTech could be liable for damages or subject to enforcement actions.

DermTech’s activities currently require the controlled use of potentially harmful biological and hazardous materials and chemicals. DermTech cannot eliminate the risk of accidental contamination or injury to employees or third parties from the use, storage, handling or disposal of these materials. In the event of contamination or injury, DermTech could be held liable for any resulting damages, and any liability could exceed DermTech’s resources or any applicable insurance coverage DermTech may have. Additionally, DermTech is subject to, on an ongoing basis, federal, state, and local laws and regulations governing the use, storage, handling, and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations may become significant and could have a material adverse effect on DermTech’s financial condition, results of operations and cash flows. In the event of an accident or if DermTech otherwise fails to comply with applicable regulations, DermTech could lose its permits or approvals or be held liable for damages or penalized with fines.

 

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DermTech may acquire other businesses, form joint ventures, or make investments in other companies or technologies that could harm DermTech’s operating results, dilute its stockholders’ ownership, increase its debt, or cause it to incur significant expense.

As part of DermTech’s business strategy, DermTech may pursue acquisitions of businesses and assets. DermTech also may pursue strategic alliances and joint ventures that leverage its core technology and industry experience to expand its offerings or distribution. DermTech has no experience with acquiring other companies and limited experience with forming strategic alliances and joint ventures. DermTech may not be able to find suitable partners or acquisition candidates, and DermTech may not be able to complete such transactions on favorable terms, if at all. If DermTech makes any acquisitions, it may not be able to integrate these acquisitions successfully into its existing business, and DermTech could assume unknown or contingent liabilities. Any future acquisitions also could result in significant write-offs or the incurrence of debt and contingent liabilities, any of which could have a material adverse effect on DermTech’s financial condition, results of operations and cash flows. Integration of an acquired company also may disrupt ongoing operations and require management resources that would otherwise focus on developing DermTech’s existing business. DermTech may experience losses related to investments in other companies, which could have a material negative effect on DermTech’s results of operations. DermTech may not identify or complete these transactions in a timely manner, on a cost-effective basis, or at all, and DermTech may not realize the anticipated benefits of any acquisition, technology license, strategic alliance, or joint venture.

To finance any acquisitions or joint ventures, DermTech may choose to issue shares of its common stock as consideration, which would dilute the ownership of DermTech’s stockholders. If the price of its common stock is low or volatile, DermTech may not be able to acquire other companies or fund a joint venture project using its stock as consideration. Alternatively, it may be necessary for DermTech to raise additional funds for acquisitions through public or private financings. Additional funds may not be available on terms that are favorable to DermTech, or at all.

International expansion of DermTech’s business would expose DermTech to business, regulatory, political, operational, financial, and economic risks associated with doing business outside of the United States.

DermTech’s business strategy contemplates possible international expansion, including partnering with academic and commercial testing laboratories, and introducing the PLA, the Nevome test, or other future products outside the United States and exporting the Adhesive Skin Sample Collection Kit. DermTech is currently testing samples through a distributor in Canada. Doing business internationally involves a number of risks, including:

 

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multiple, conflicting, and changing laws and regulations such as tax laws, export and import restrictions, privacy, data security and data transfer laws, employment laws, intellectual property laws, regulatory requirements, and other governmental approvals, permits and licenses;

 

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failure by DermTech or its distributors to obtain regulatory approvals for the sale or use of DermTech’s current tests and its planned future tests in various countries;

 

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difficulties in managing foreign operations;

 

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complexities associated with managing government payer systems, multiple payer-reimbursement regimes, or self-pay systems;

 

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logistics and regulations associated with shipping blood samples, including infrastructure conditions and transportation delays;

 

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limits on DermTech’s ability to penetrate international markets if its current tests and its planned future diagnostic tests cannot be processed by an appropriately qualified local laboratory;

 

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financial risks, such as longer payment cycles, difficulty enforcing contracts and collecting accounts receivable and exposure to foreign currency exchange rate fluctuations;

 

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reduced protection for intellectual property rights, or lack of them in certain jurisdictions, forcing more reliance on any trade secrets DermTech may have, if such protection is available;

 

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natural disasters, political and economic instability, including wars, terrorism and political unrest, outbreak of disease, boycotts, curtailment of trade, and other business restrictions; and

 

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failure to comply with the Foreign Corrupt Practices Act, including its books and records provisions and its anti-bribery provisions, by maintaining accurate information and control over sales activities and distributors’ activities.

Any of these risks, if encountered, could significantly harm DermTech’s future international expansion and operations and, consequently, have a material adverse effect on DermTech’s financial condition, results of operations, and cash flows.

Declining general economic or business conditions may have a negative impact on DermTech’s business.

Continuing concerns over United States health care reform legislation and energy costs, geopolitical issues, the availability and cost of credit, and government stimulus programs in the United States and other countries have contributed to increased volatility and diminished expectations for the global economy. These factors, combined with low business and consumer confidence and high unemployment, precipitated an economic slowdown and recession. If the economic climate does not improve, or it deteriorates, DermTech’s business, including DermTech’s access to patient samples and the addressable market for diagnostic tests that DermTech may successfully develop, as well as the financial condition of DermTech’s suppliers and its third-party payers, could be adversely affected, resulting in a negative impact on DermTech’s business, financial condition, and results of operations.

Intrusions into DermTech’s computer systems could result in compromise of confidential information.

Despite the implementation of security measures, DermTech’s technology or systems that it interfaces with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, computer viruses, programming errors, or similar problems. Any of these might result in confidential medical, business, or payment information, including as may be disclosed as part of a credit card transaction, or other information of other persons or of DermTech, including employees, being revealed to unauthorized persons.

DermTech must comply with complex and overlapping laws protecting the privacy and security of health information and personal data.

There are a number of state, federal and international laws protecting the privacy and security of health information and personal data. As part of the American Recovery and Reinvestment Act 2009, or ARRA, Congress amended and strengthened the privacy and security provisions of the Health Insurance Portability and Accountability Act of 1996, or HIPAA. HIPAA imposes limitations on the use and disclosure of an individual’s healthcare information by healthcare providers, healthcare clearinghouses, and health insurance plans, collectively referred to as covered entities. HIPAA also imposes compliance obligations and corresponding penalties for non-compliance on individuals and entities that provide services to healthcare providers and other covered entities, collectively referred to as business associates. ARRA also made significant increases in the penalties for improper use or disclosure of an individual’s health information under HIPAA and extended enforcement authority to state attorneys general. The amendments also created notification requirements for individuals whose health information has been inappropriately accessed or disclosed: notification requirements to federal regulators and in some cases, notification to local and national media. Notification is not required under HIPAA if the health information that is improperly used or disclosed is deemed secured in accordance with encryption or other standards developed by the U.S. Department of Health and Human Services, or HHS. Most states have adopted laws requiring notification of affected individuals and state regulators in the event of a

 

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breach of personal information, which is a broader class of information than the health information protected by HIPAA. Many state laws impose significant data security requirements, such as encryption or mandatory contractual terms to ensure ongoing protection of personal information. Activities outside of the United States implicate local and national data protection standards, impose additional compliance requirements, and generate additional risks of enforcement for non-compliance. DermTech must comply with all applicable privacy and data security laws in order to operate its business and may be required to expend significant capital and other resources to ensure ongoing compliance, to protect against security breaches and hackers or to alleviate problems caused by such breaches. Breaches of health information and/or personal data may be extremely expensive to remediate, may prompt federal or state investigation, fines, civil and/or criminal sanctions and significant reputational damage.

DermTech may have to comply with laws governing the use and disclosure of genetic testing information.

Many states have adopted laws governing genetic testing and the use and disclosure of genetic test results. These laws impose specific testing consent requirements, patient authorization requirements for the use and disclosure of test results and some impose limits on the retention and secondary use of patient samples. Many of these laws are vaguely written and some are overly broad. DermTech must analyze and ensure compliance with the genetic testing laws in the jurisdictions from which DermTech obtains samples and may be required to expend significant capital and other resources to ensure ongoing compliance. DermTech’s failure to comply could interfere with DermTech’s ability to operate and/or lead to sanctions, fines, or other regulatory actions as well as civil claims.

DermTech depends on its information technology and telecommunications systems, and any failure of these systems could harm its business.

DermTech depends on information technology and telecommunications systems for significant aspects of its operations. In addition, DermTech’s third-party billing and collections provider depends upon telecommunications and data systems provided by outside vendors and information DermTech provides on a regular basis. These information technology and telecommunications systems support a variety of functions, including test processing, sample tracking, quality control, customer service and support, billing and reimbursement, research and development activities, and DermTech’s general and administrative activities. Information technology and telecommunications systems are vulnerable to damage from a variety of sources, including telecommunications or network failures, malicious human acts, and natural disasters. Moreover, despite network security and back-up measures, some of DermTech’s servers are potentially vulnerable to physical or electronic break-ins, computer viruses, and similar disruptive problems. Despite the precautionary measures DermTech has taken to prevent unanticipated problems that could affect its information technology and telecommunications systems, failures or significant downtime of DermTech’s information technology or telecommunications systems, or those used by DermTech’s third-party service providers could prevent DermTech from processing tests, providing test results to oncologists, pathologists, billing payers, processing reimbursement appeals, handling patient or physician inquiries, conducting research and development activities, and managing the administrative aspects of DermTech’s business. Any disruption or loss of information technology or telecommunications systems on which critical aspects of DermTech’s operations depend could have an adverse effect on its business.

DermTech relies on Federal Express Corporation, or FedEx, and United Parcel Service of America, Inc., or UPS, for the distribution of its products and, if FedEx or UPS incurs any damage to the facilities where DermTech products are located or is unable to distribute DermTech’s products as needed, it could have a material adverse effect on DermTech’s results of operations and business.

DermTech relies on FedEx and UPS for the distribution of its products. The FedEx or UPS facilities where DermTech products are located may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, power outages, communications failure, or terrorism. Any material destruction to the

 

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facilities where DermTech’s products are located could adversely affect the ability of FedEx or UPS to meet the needs of DermTech’s customers. In addition, a disruption or slowdown in the operations of FedEx or UPS, including as a result of damage to the facilities of FedEx or UPS or a strike by FedEx or UPS employees, could cause delays in DermTech’s ability to fulfill customer orders and may cause orders to be cancelled, lost, or delivered late, DermTech’s products to be returned, or receipt of products to be refused, any of which could adversely affect DermTech’s business and its results of operations. If DermTech’s shipping costs were to increase as a result of an increase by FedEx or UPS or as a result of obtaining a new third-party logistics company and if DermTech is unable to pass on these higher costs to its customers, it could have a material adverse effect on DermTech’s results of operations and business.

Regulatory Risks Relating to DermTech’s Business

Healthcare policy changes, including recently enacted legislation reforming the U.S. health care system, may have a material adverse effect on DermTech’s financial condition, results of operations, and cash flows.

The 2010 Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or collectively the ACA, makes a number of substantial changes in the way health care is financed by both governmental and private insurers. The ACA made a number of substantial changes to the way healthcare is financed both by governmental and private insurers. For example, the ACA requires each medical device manufacturer to pay an excise tax on the medical devices it sells. The medical device tax has been suspended through 2019. It is unclear at this time when, or if, sales of DermTech’s laboratory developed tests, or LDTs, will trigger the medical device tax, and it is possible that this tax will apply to some or all of DermTech’s existing tests or tests it may develop in the future. Additionally, the ACA introduces mechanisms to reduce the per capita rate of growth in Medicare spending if expenditures exceed certain targets. Any such reductions could affect reimbursement payments for DermTech’s tests. The ACA also contains a number of other provisions, including provisions governing enrollment in federal and state healthcare programs, reimbursement matters, and fraud and abuse, which DermTech expects will impact its industry and its operations in ways that DermTech cannot currently predict.

Among other things, the ACA:

 

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establishes an Independent Payment Advisory Board to reduce the per capita rate of growth in Medicare spending if spending exceeds a target growth rate. The Independent Payment Advisory Board has broad discretion to propose policies, which may have a negative impact on payment rates for services, including clinical laboratory services, beginning in 2016, and for hospital services beginning in 2020; and

 

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established the Physician Payments Sunshine Act, or the Sunshine Act, which imposes new reporting and disclosure requirements for applicable device manufacturers of covered products and those entities under common ownership that provide assistance and support to applicable manufacturers, with regard to payments or other transfers of value made to certain practitioners (including physicians and teaching hospitals) and certain investment ownership interests held by physicians in the reporting entity.

DermTech cannot predict whether or when these or other recently enacted healthcare initiatives will be implemented at the federal or state level or how any such legislation or regulation may affect DermTech. For instance, the payment reductions imposed by the ACA and the changes to reimbursement amounts paid by Medicare for tests such as DermTech based on the procedure set forth in PAMA, could limit the prices DermTech will be able to charge or the amount of available reimbursement for DermTech’s tests, which would reduce its revenue. Additionally, these healthcare policy changes could be amended or additional healthcare initiatives could be implemented in the future. For instance, there is uncertainty regarding the continued effect of the ACA in its current form following the results of the 2016 U.S. presidential election and in light of the policies of the current administration, which has threatened to repeal, replace, or change the ACA. Further, the impact on DermTech’s business of the expansion of the federal and state governments’ role in the U.S. healthcare industry

 

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generally, including the social, governmental, and other pressures to reduce healthcare costs while expanding individual benefits, is uncertain. Any future changes or initiatives could have a materially adverse effect on DermTech’s business, financial condition, results of operations, and cash flows.

Currently, DermTech is not subject to the Sunshine Act provisions of the ACA. However, if in the future the FDA determines that the Adhesive Skin Sample Collection Kit or any of DermTech’s current or future products are subject to premarket clearance or approval process, DermTech would be subject to the Physician Payments Sunshine Act.

The final rule implementing the Sunshine Act is complex, ambiguous, and broad in scope. If DermTech is considered an “applicable manufacturer” under the Sunshine Act it will be subject to reporting requirements. In addition, certain of DermTech’s subsidiaries may be found to be subject to the reporting requirements to the extent they provide assistance and support to DermTech with respect to the manufacturing, marketing promotion, sale or distribution of DermTech’s covered products. It is difficult to predict how the new requirements may impact existing relationships among manufacturers, distributors, physicians, and teaching hospitals. The Sunshine Act preempts similar state reporting laws, although DermTech or its subsidiaries may be required to continue to report under certain provisions of such state laws. Failure to comply with the Sunshine Act may subject DermTech to civil monetary penalties.

The U.S. federal government continues to show significant interest in pursuing health care reform and reducing health care costs. Similarly, commercial third-party payers may seek to reduce costs by reducing coverage or reimbursement for DermTech’s tests. Any government-adopted reform measures or changes to commercial third-party payer coverage and reimbursement policies could cause significant pressure on the pricing of, and reimbursement for, health care products and services, including DermTech’s tests, which could decrease demand for DermTech’s tests, and adversely affect DermTech’s sales and revenue.

In addition, some payers have implemented, or are in the process of implementing, laboratory benefit management programs, often using third-party benefit managers to manage these programs. The stated goals of these programs are to help improve the quality of outpatient laboratory services, support evidence-based guidelines for patient care and lower costs. The impact on laboratories, such as DermTech, of active laboratory benefit management by third parties is unclear, and DermTech expects that it would have a negative impact on its revenue in the short term. It is possible that payers will resist reimbursement for tests that DermTech offers, in favor of less expensive tests, may require pre-approval for DermTech’s tests or may impose additional pricing pressure on and substantial administrative burden for reimbursement for DermTech’s tests. DermTech expects to continue to focus substantial resources on increasing adoption of, and coverage and reimbursement for, DermTech’s current tests and any future tests it may develop. DermTech believes it may take several years to achieve broad coverage and adequate contracted reimbursement with a majority of payers for DermTech’s tests. However, DermTech cannot predict whether, under what circumstances, or at what payment levels payers will cover and reimburse DermTech’s tests. If DermTech fails to establish and maintain broad adoption of, and coverage and reimbursement for, its tests, DermTech’s ability to generate revenue could be harmed and its future prospects and its business could suffer.

DermTech’s business could be adversely impacted by its failure or the failure of physicians to comply with the ICD-10-CM Code Set.

CMS adopted a new coding set for diagnoses, commonly known as ICD-10-CM, which significantly expanded the previous coding set. Compliance with ICD-10-CM is required for all claims with dates of service on or after October 1, 2015. DermTech believes it has fully implemented ICD-10-CM, however, DermTech’s failure to implement and apply the new code set could adversely impact its business. In addition, if physicians fail to provide appropriate codes for desired tests, DermTech may not be reimbursed for tests it performs.

 

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Billing for DermTech’s tests is complex and DermTech must dedicate substantial time and resources to the billing process to be paid for its tests; long payment cycles of Medicare, Medicaid, and/or other third-party payers, or other payment delays, could hurt DermTech’s cash flows and increase its need for working capital.

Billing for clinical laboratory testing services is complex, time-consuming, and expensive. Depending on the billing arrangement and applicable law, DermTech will bill various payers, including Medicare, Medicaid, private insurance companies, and patients, all of which have different billing requirements. To the extent laws or contracts require DermTech to bill patient co-payments or co-insurance, DermTech must also comply with these requirements. DermTech may also face increased risks in its collection efforts, including potential write-offs of doubtful accounts, long collection cycles, and failure by third parties to properly process payment of claims in a timely manner which could adversely affect DermTech‘s business, results of operations, and financial condition. Several factors make the billing practice complex, including:

 

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compliance with complex federal and state regulations related to Medicare billing;

 

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disputes among payers as to which party is responsible for payment; resistance by patients to cover any substantial amount of the payment;

 

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differences in coverage among payers and effect of patient co-payments or co-insurance;

 

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differences in information and billing requirements among payers;

 

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incorrect or missing billing information; and

 

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the resources required to manage the billing and claims appeals process.

Additionally, DermTech’s billing activities require it to implement compliance procedures and oversight, train and monitor its employees, challenge coverage and payment denials, assist patients in appealing claims, and undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. Payers also conduct external audits to evaluate payments, which add further complexity to the billing process.

Failure to comply with these billing requirements may result in non-payment, refunds, exclusion from government healthcare programs, and civil or criminal liabilities, any of which may have a material adverse effect on DermTech’s revenues and earnings. These billing complexities and the related uncertainties in obtaining reimbursement could negatively affect DermTech’s cash flow and DermTech’s ability to achieve profitability.

DermTech’s business could be harmed by the loss, suspension, or other restriction on a license, certification, or accreditation, or by the imposition of a fine or penalties, under CLIA, its implementing regulations, or other state, federal, and foreign laws and regulations affecting licensure or certification, or by future changes in these laws or regulations.

The diagnostic testing industry is subject to extensive laws and regulations, many of which have not been interpreted by the courts. CLIA requires virtually all laboratories to be certified by the federal government and mandates compliance with various operational, personnel, facilities administration, quality, and proficiency testing requirements intended to ensure that testing services are accurate, reliable, and timely. CLIA certification is also a prerequisite to be eligible to bill state and federal health care programs, as well as many private third-party payers, for laboratory testing services. DermTech’s clinical laboratory must be certified under CLIA in order for it to perform testing on human specimens. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management, quality control, quality assurance, and inspections. DermTech has a current certificate of registration from CMS to perform high-complexity testing, which is managed by California Laboratory Field Services, or CA LFS. To renew this certificate, DermTech is subject to survey and inspection every two years. Moreover, CA LFS and/or CLIA

 

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inspectors may make periodic inspections of DermTech’s clinical laboratory outside of the renewal process. The biennial survey is conducted by CMS, a CMS agent (typically a state agency), or, if the laboratory holds a CLIA certificate of accreditation, a CMS-approved accreditation organization. Sanctions for failure to comply with CLIA requirements, including proficiency testing violations, may include suspension, revocation, or limitation of a laboratory’s CLIA certificate, which is necessary to conduct business, as well as the imposition of significant fines or criminal penalties. In addition, DermTech is subject to regulation under state laws and regulations governing laboratory licensure. Some states have enacted state licensure laws that are more stringent than CLIA.

In addition, state and foreign requirements for laboratory certification may be costly or difficult to meet and could affect DermTech’s ability to receive specimens from certain states or foreign countries. Currently DermTech is receiving samples from all 50 U.S. states and certain provinces in Canada. Each state maintains independent licensure, registration, or certification procedures that it must maintain compliance with in order to receive and test samples from that location. Maintaining compliance with the myriad of state and foreign requirements is time consuming and resource intensive and failure to maintain compliance could result in sanctions.

Any sanction imposed under CLIA, its implementing regulations, or state or foreign laws or regulations governing licensure, or DermTech’s failure to renew a CLIA certificate, a state or foreign license, or accreditation, could have a material adverse effect on DermTech’s business. If the CLIA certificate of DermTech’s laboratory is revoked, that could also impact DermTech’s licensure or certification in the states or in foreign jurisdictions.

DermTech is also accredited from the College of American Pathologists, or CAP, which is a higher standard than that of the CLIA regulations. CAP is an independent, non-governmental organization of board-certified pathologists that accredits laboratories nationwide on a voluntary basis and that has been recognized by CMS as an accreditation organization to inspect laboratories to determine adherence to the CLIA standards. Since CAP has deemed status with CA LFS, DermTech’s post-CAP re-accreditation inspections will be performed by teams formed by CAP. While not required to operate a CLIA-certified laboratory, many private insurers require CAP accreditation as a condition to contracting with clinical laboratories to cover their tests. In addition, some countries outside the United States require CAP accreditation as a condition to permitting clinical laboratories to test samples taken from their citizens. Failure to maintain CAP accreditation could have a material adverse effect on the sales of DermTech’s tests and the results of its operations.

If DermTech were to lose its CLIA certification, CAP accreditation or California laboratory license, whether as a result of a revocation, suspension, or limitation, DermTech would no longer be able to offer its tests, which would limit its revenues and harm its business. If DermTech were to lose its license in any other state where it is required to hold a license, DermTech would not be able to test specimens from those states

If the FDA were to begin requiring approval or clearance of DermTech’s current tests and its planned future tests, DermTech could incur substantial costs and time delays associated with meeting requirements for premarket clearance or approval or DermTech could experience decreased demand for, or reimbursement of, its tests.

Although the FDA maintains that it has authority to regulate the development and use of LDTs, such as DermTech’s and many other laboratories’ test as medical devices, it has not exercised its authority with respect to most LDTs as a matter of enforcement discretion. The FDA could, at any time, change its policy with regard to this matter.

DermTech believes that its tests, as utilized in its clinical laboratory, are and would be LDTs. As a result, DermTech believes that pursuant to the FDA’s current policies and guidance, the FDA does not require that DermTech obtain regulatory clearances or approvals for DermTech’s LDTs. DermTech believes the Adhesive Skin Sample Collection Kit it provides for collection and transport of skin samples from a health care provider to

 

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DermTech’s clinical laboratory is considered a Class I medical device subject to the FDA regulation, but is currently exempt from premarket review by the FDA. However, the FDA could assert this device is Class II, which would subject it and DermTech’s assay to premarket clearance or approval processes, which could be time-consuming and expensive. While DermTech believes that it is currently in material compliance with applicable laws and regulations, DermTech cannot assure you that the FDA, or other regulatory agencies, would agree with its determination, and a determination that it has violated these laws, or a public announcement that DermTech is being investigated for possible violations of these laws, could adversely affect DermTech’s business, prospects, results of operations, or financial condition.

Even though DermTech commercializes its tests as LDTs, DermTech’s tests may in the future become subject to more onerous regulation by the FDA. For example, the FDA may disagree with DermTech’s assessment that its tests fall within the definition of an LDT and seek to regulate DermTech’s tests as medical devices. Moreover, the FDA has issued draft guidance and a 2017 Discussion Paper to allow for further public discussion about an appropriate LDT oversight approach and to give congressional committees the opportunity to develop a legislative solution. The FDA has also solicited public input and published two draft guidance documents relating to FDA oversight of NGS-based tests. These two draft guidance documents describe the FDA’s thinking and proposed approach regarding the possible use of FDA-recognized standards to support analytical validity, and public human genetic variant databases to support clinical validity, of these tests. Additionally, two different bi-partisan bills have been circulated as discussion drafts in Congress, both of which reflect FDA policy positions and seek to establish new regulatory frameworks for laboratory testing, including the type of testing DermTech provides.

If the FDA begins to enforce its medical device requirements for LDTs, or if the FDA disagrees with DermTech’s assessment that its tests are LDTs, DermTech could for the first time be subject to enforcement of a variety of regulatory requirements, including registration and listing, medical device reporting, and quality control, and DermTech could be required to obtain premarket clearance or approval for its existing tests and any new tests it may develop, which may force DermTech to cease marketing its tests until it obtains the required clearance or approval. The premarket review process can be lengthy, expensive, time-consuming, and unpredictable. Further, obtaining premarket clearance may involve, among other things, successfully completing clinical trials. Clinical trials require significant time and cash resources and are subject to a high degree of risk, including risks of experiencing delays, failing to complete the trial or obtaining unexpected or negative results. If DermTech is required to obtain premarket clearance or approval and/or conduct premarket clinical trials, DermTech’s development costs could significantly increase, DermTech’s introduction of any new tests it may develop may be delayed, and sales of DermTech’s existing tests could be interrupted or stopped. Any of these outcomes could reduce DermTech’s revenue or increase its costs and materially adversely affect its business, prospects, results of operations, or financial condition. Moreover, any cleared or approved labeling claims may not be consistent with DermTech’s current claims or adequate to support continued adoption of and reimbursement for DermTech’s tests. For instance, if DermTech is required by the FDA to label DermTech’s tests as investigational, or if labeling claims the FDA allows DermTech to make are limited, order levels may decline and reimbursement may be adversely affected. As a result, DermTech could experience significantly increased development costs and a delay in generating additional revenue from its existing tests or from tests it may develop.

The requirement of premarket review could negatively affect DermTech’s business until such review is completed and clearance to market or approval is obtained. The FDA could require that DermTech stop selling its tests pending premarket clearance or approval. If the FDA allows DermTech’s tests to remain on the market but there is uncertainty about DermTech’s tests, if they are labeled investigational by the FDA, or if labeling claims the FDA allows DermTech to make are limited, orders from dermatologists or reimbursement may decline. The regulatory approval process may involve, among other things, successfully completing additional clinical trials and making a 510(k) or other premarket submission, or filing a premarket approval application, or PMAA, with the FDA. If the FDA requires premarket review, DermTech’s tests may not be cleared or approved

 

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on a timely basis, if at all. DermTech may also decide voluntarily to pursue FDA premarket review of DermTech’s tests if DermTech determines that doing so would be appropriate.

Additionally, should future regulatory actions affect any of the reagents DermTech obtains from suppliers and uses in conducting DermTech’s tests, DermTech’s business could be adversely affected in the form of increased costs of testing or delays, limits, or prohibitions on the purchase of reagents necessary to perform DermTech’s testing. While DermTech qualifies all materials used in its products in accordance with the regulations and guidelines of the CLIA, the FDA could promulgate regulations or guidance documents impacting DermTech’s ability to purchase materials necessary for the performance of its tests. If any of the reagents DermTech obtains from suppliers and uses in its tests are affected by future regulatory actions, DermTech’s business could be adversely affected, including by increasing the cost of testing or delaying, limiting, or prohibiting the purchase of reagents necessary to perform testing with DermTech’s products.

If DermTech were required to conduct additional clinical studies or trials before continuing to offer tests that it has developed or may develop as LDTs, those studies or trials could lead to delays or failure to obtain necessary regulatory approval, which could cause significant delays in commercializing any future products and harm DermTech’s ability to achieve sustained profitability.

If the FDA decides to require that DermTech obtain 510(k) clearance, premarket approvals pursuant to a PMAA, or any other type of premarket submission in order to commercialize DermTech’s current PLA, the Nevome test, or DermTech’s planned future tests, DermTech may be required to conduct additional premarket clinical testing before submitting a regulatory notification or application for commercial sales. In addition, as part of DermTech’s long-term strategy DermTech may plan to seek FDA clearance or approval; however, DermTech would need to conduct additional clinical validation activities on its tests before it can submit an application for FDA approval or clearance. Clinical trials must be conducted in compliance with FDA regulations or the FDA may take enforcement action or reject the data. The data collected from these clinical trials may ultimately be used to support market clearance or approval for DermTech’s tests. DermTech believes it would likely take two years or more to conduct the clinical studies and trials necessary to obtain approval from the FDA to commercially launch DermTech’s current tests and DermTech’s planned future tests outside of its clinical laboratory. Even if DermTech’s clinical trials are completed as planned, DermTech cannot be certain that their results will support DermTech’s test claims or that the FDA or foreign authorities will agree with DermTech’s conclusions regarding the results of its clinical trials. Success in early clinical trials does not ensure that later clinical trials will be successful, and DermTech cannot be sure that the later trials will replicate the results of prior clinical trials and studies. If DermTech is required to conduct premarket clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase DermTech’s test development costs and delay commercialization. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial. Moreover, the clinical trial process may fail to demonstrate that DermTech’s current tests and DermTech’s planned future tests are effective for the proposed indicated uses, which could cause DermTech to abandon a test candidate and may delay development of other tests.

DermTech may find it necessary to engage contract research organizations to perform data collection and analysis and other aspects of its clinical trials, which would increase the cost and complexity of DermTech’s trials. DermTech may also depend on clinical investigators, medical institutions, and contract research organizations to perform the trials properly. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality, completeness, or accuracy of the clinical data they obtain is compromised due to the failure to adhere to DermTech’s clinical protocols or for other reasons, DermTech’s clinical trials may have to be extended, delayed or terminated. Many of these factors would be beyond DermTech’s control. DermTech may not be able to enter into replacement arrangements without undue

 

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delays or considerable expenditures. If there are delays in testing or approvals as a result of the failure to perform by third parties, DermTech’s research and development costs would increase, and DermTech may not be able to obtain regulatory clearance or approval for DermTech’s current tests and its planned future tests. In addition, DermTech may not be able to establish or maintain relationships with these parties on favorable terms, if at all. Each of these outcomes would harm DermTech’s ability to market its tests or to achieve sustained profitability.

If DermTech fails to comply with the complex federal, state, local and foreign laws and regulations that apply to its business, DermTech could suffer severe consequences that could materially and adversely affect its operating results and financial condition.

DermTech’s operations are subject to extensive federal, state, local and foreign laws and regulations, all of which are subject to change. These laws and regulations currently include, among other things:

 

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CLIA, which requires that laboratories obtain certification from the federal government, and state licensure laws;

 

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FDA laws and regulations;

 

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HIPAA, which imposes comprehensive federal standards with respect to the privacy and security of protected health information and requirements for the use of certain standardized electronic transactions; amendments to HIPAA under the Health Information Technology for Economic and Clinical Health Act, or HITECH, which strengthen and expand HIPAA privacy and security compliance requirements, increase penalties for violators, extend enforcement authority to state attorneys general and impose requirements for breach notification;

 

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state laws regulating genetic testing and protecting the privacy of genetic test results, as well as state laws protecting the privacy and security of health information and personal data and mandating reporting of breaches to affected individuals and state regulators;

 

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the federal anti-kickback law, or the Anti-Kickback Statute, which prohibits knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for, or recommending of an item or service that is reimbursable, in whole or in part, by a federal health care program;

 

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the federal False Claims Act, which imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment to the federal government;

 

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

 

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other federal and state fraud and abuse laws, such as anti-kickback laws, prohibitions on self-referral, and false claims acts, which may extend to services reimbursable by any third-party payer, including private insurers;

 

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the Sunshine Act, which requires medical device manufactures to track and report to the federal government certain payments and other transfers of value made to physicians and teaching hospitals and ownership or investment interests held by physicians and their immediate family members;

 

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Section 216 of the PAMA, which requires applicable laboratories to report private payer data in a timely and accurate manner beginning in 2017 and every three years thereafter (and in some cases annually);

 

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state laws that impose reporting and other compliance-related requirements; and

 

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similar foreign laws and regulations that apply to DermTech in the countries in which DermTech operates. These laws and regulations are complex and are subject to interpretation by the courts and by government agencies. DermTech’s failure to comply could lead to civil or criminal penalties, exclusion from participation in state and federal health care programs, or prohibitions or restrictions on DermTech’s laboratories’ ability to provide or receive payment for DermTech’s services. DermTech believes that it is in material compliance with all statutory and regulatory requirements, but there is a risk that one or more government agencies could take a contrary position, or that a private party could file suit under the qui tam provisions of the federal False Claims Act or a similar state law. Such occurrences, regardless of their outcome, could damage DermTech’s reputation and adversely affect important business relationships with third parties, including managed care organizations, and other private third-party payers.

These laws and regulations are complex and are subject to interpretation by the courts and by government agencies. DermTech’s failure to comply could lead to civil or criminal penalties, exclusion from participation in state and federal health care programs, or prohibitions or restrictions on DermTech’s laboratories’ ability to provide or receive payment for its services. DermTech believes that it is in material compliance with all statutory and regulatory requirements, but there is a risk that one or more government agencies could take a contrary position, or that a private party could file suit under the qui tam provisions of the federal False Claims Act or a similar state law. Such occurrences, regardless of their outcome, could damage DermTech’s reputation and adversely affect important business relationships with third parties, including managed care organizations, and other private third-party payers.

DermTech is subject to numerous federal and state healthcare statutes and regulations; complying with laws pertaining to its business is an expensive and time-consuming process, and any failure to comply could result in substantial penalties and a material adverse effect to its business and operations.

Federal and state laws related to, among other things, unlawful schemes to defraud, excessive fees for services, unlawful trade practices, kickbacks, patient inducement and statutory or common law fraud restrict the provision of items or services for free or at reduced charge to government health care program beneficiaries. Such state laws may also restrict the provision of items or services for free or at a reduced charge to non-government health care program beneficiaries. These laws and regulations relating to the provision of items or services for free are complex and are subject to interpretation by the courts and by government agencies. DermTech does not currently charge Medicare or Medicaid beneficiaries for its tests nor does DermTech submit claims to any federal healthcare program.

To the extent DermTech’s business operations are found to be in violation of any of these laws or any other governmental regulations that may apply to DermTech, it may be subject to significant civil, criminal and administrative penalties, including, without limitation, damages, monetary fines, individual imprisonment, disgorgement of profits, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional reporting or oversight obligations if DermTech becomes subject to a corporate integrity agreement or other agreement to resolve allegations of non-compliance with the law and curtailment or restructuring of DermTech’s operations, any of which could adversely affect DermTech’s ability to operate its business and pursue its strategy. If any of the physicians or other healthcare providers or entities with whom DermTech expects to do business, including current or future collaborators, are found not to be in compliance with applicable laws, they may be subject to criminal, civil or administrative sanctions, including exclusions from participation in government healthcare programs, which could also affect DermTech’s business.

As a clinical laboratory, DermTech’s business practices may face additional scrutiny from government regulatory agencies such as the Department of Justice, the U.S. Department of Health and Human Services Office of Inspector General, or OIG, and CMS. Certain arrangements between clinical laboratories and referring physicians have been identified in fraud alerts issued by the OIG as implicating the Anti-Kickback Statute. The

 

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OIG has stated that it is particularly concerned about these types of arrangements because the choice of laboratory, as well as the decision to order laboratory tests, typically are made or strongly influenced by the physician, with little or no input from patients. Moreover, the provision of payments or other items of value by a clinical laboratory to a referral source could be prohibited under the Stark Law unless the arrangement meets all criteria of an applicable exception. The government has been active in enforcement of these laws as they apply to clinical laboratories.

Numerous states have enacted laws prohibiting business corporations, such as DermTech, from practicing medicine and other professions and from employing or engaging physicians and other professionals to practice medicine, generally referred to as the prohibition against the corporate practice of medicine and the professions, which could include physician laboratory directors. These laws are designed to prevent interference in the medical decision-making process by anyone who is not a licensed professional. For example, California’s Medical Board has indicated that determining the appropriate diagnostic tests for a particular condition and taking responsibility for the ultimate overall care of a patient, including providing treatment options available to the patient, would constitute the unlicensed practice of medicine if performed by an unlicensed person. Violation of these corporate practice of medicine laws may result in civil or criminal fines, as well as sanctions imposed against the business corporation and/or the professional through licensure proceedings and criminal penalties.

The growth of DermTech’s business and its expansion outside of the United States may increase the potential of violating similar foreign laws or DermTech’s internal policies and procedures. The risk of DermTech being found in violation of these or other laws and regulations is further increased by the fact that many have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action brought against DermTech for violation of these or other laws or regulations, even if DermTech successfully defend against it, could cause DermTech to incur significant legal expenses and divert DermTech’s management’s attention from the operation of its business. Any of the foregoing consequences could seriously harm DermTech’s business and its financial results.

DermTech may be required to comply with laws and contractual obligations governing the transmission, security, and privacy of health information, or other information, including personally identifiable information and payment information, including credit card information, that require significant compliance costs, and any failure to comply with these laws could result in material criminal and civil penalties.

Under the administrative simplification provisions of HIPAA, HHS has issued regulations which establish uniform standards governing the conduct of certain electronic health care transactions and protecting the privacy and security of PHI used or disclosed by health care providers and other covered entities.

The privacy regulations regulate the use and disclosure of PHI by health care providers engaging in certain electronic transactions or “standard transactions.” They also set forth certain rights that an individual has with respect to his or her PHI maintained by a covered health care provider, including the right to access or amend certain records containing PHI or to request restrictions on the use or disclosure of PHI. The HIPAA security regulations establish administrative, physical, and technical standards for maintaining the integrity and availability of PHI in electronic form. These standards apply to covered health care providers and also to “business associates” or third parties providing services involving the use or disclosure of PHI. The HIPAA privacy and security regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their records containing PHI. As a result, DermTech may be required to comply with both HIPAA privacy regulations and varying state privacy and security laws.

Moreover, HITECH, among other things, established certain health information security breach notification requirements. In the event of a breach of unsecured PHI, a covered entity must notify each individual whose PHI is breached, federal regulators and in some cases, must publicize the breach in local or national media. Breaches affecting 500 individuals or more are publicized by federal regulators who publicly identify the breaching entity, the circumstances of the breach and the number of individuals affected.

 

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These laws contain significant fines and other penalties for wrongful use or disclosure of PHI. Given the complexity of HIPAA and HITECH and their overlap with state privacy and security laws, and the fact that these laws are rapidly evolving and are subject to changing and potentially conflicting interpretation, DermTech’s ability to comply with the HIPAA, HITECH and state privacy requirements is uncertain and the costs of compliance are significant. Adding to the complexity is that DermTech’s operations are evolving and the requirements of these laws will apply differently depending on such things as whether or not DermTech bills electronically for its services, or provide services involving the use or disclosure of PHI and incur compliance obligations as a business associate. The costs of complying with any changes to the HIPAA, HITECH and state privacy restrictions may have a negative impact on DermTech’s operations. Noncompliance could subject DermTech to criminal penalties, civil sanctions and significant monetary penalties as well as reputational damage.

DermTech also is required to collect and maintain personal information about its employees, and DermTech collects information about customers as part of some of its marketing programs, as well as receives and transfers certain payment information, to accept payments from its customers, including credit card information. The collection and use of such information is regulated at the federal and state levels, and may be subject to contractual obligations as well. The regulatory environment related to information security and privacy is increasingly demanding. If the security and information systems that DermTech or its outsourced third party providers use to store or process such information are compromised or if DermTech, or such third parties, otherwise fail to comply with these laws, regulations, and contractual obligations, DermTech could face litigation and the imposition of penalties that could adversely affect DermTech’s financial performance. DermTech’s reputation as a brand or as an employer could also be adversely affected from these types of security breaches or regulatory violations, which could impair DermTech’s sales or ability to attract and keep qualified employees.

Clinical research is heavily regulated and failure to comply with human subject protection regulations may disrupt DermTech’s research program leading to significant expense, regulatory enforcement, private lawsuits, and reputational damage.

Clinical research is subject to federal, state, and, for studies conducted outside of the United States, international regulation. At the federal level, the FDA imposes regulations for the protection of human subjects and requirements such as initial and ongoing institutional review board review; informed consent requirements, adverse event reporting and other protections to minimize the risk and maximize the benefit to research participants. Many states impose human subject protection laws that mirror or in some cases exceed federal requirements. HIPAA also regulates the use and disclosure of PHI in connection with research activities. Research conducted overseas is subject to a variety of national protections such as mandatory ethics committee review, as well as laws regulating the use, disclosure and cross-border transfer of personal data. The costs of compliance with these laws may be significant and compliance with regulatory requirements may result in delay. Noncompliance may disrupt DermTech’s research and result in data that is unacceptable to regulatory authorities, data lock, or other sanctions that may significantly disrupt DermTech’s operations.

Violation of a state’s prohibition on the corporate practice of medicine could result in a material adverse effect on DermTech’s business.

A number of states, including California, do not allow business corporations to employ physicians to provide professional services. This prohibition against the “corporate practice of medicine” is aimed at preventing corporations such as DermTech from exercising control over the medical judgments or decisions of physicians. The state licensure statutes and regulations and agency and court decisions that enumerate the specific corporate practice rules vary considerably from state to state and are enforced by both the courts and regulatory authorities, each with broad discretion. If regulatory authorities or other parties in any jurisdiction successfully assert that DermTech is engaged in the unauthorized corporate practice of medicine, DermTech could be required to restructure its contractual and other arrangements. In addition, violation of these laws may result in sanctions imposed against DermTech and/or the professional through licensure proceedings, and DermTech could be subject to civil and criminal penalties that could result in exclusion from state and federal health care programs.

 

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If DermTech is sued for product liability or errors and omissions liability, it could face substantial liabilities that exceed its resources.

The marketing, sale and use of DermTech’s PLA could lead to product liability claims if someone were to allege that it failed to perform as it was designed. DermTech may also be subject to liability for errors in results DermTech provides to physicians or for misunderstanding of, or inappropriate reliance upon, the information DermTech provides. DermTech may also be subject to similar types of claims related to products DermTech may develop in the future. A product liability or errors and omissions liability claim could result in substantial damages and be costly and time-consuming for DermTech to defend. Although DermTech maintains product liability and errors and omissions insurance, DermTech cannot assure you that its insurance would fully protect it from the financial impact of defending against these types of claims, or any judgments, fines or settlement costs arising out of any such claims. Any product liability or errors and omissions liability claim brought against DermTech, with or without merit, could increase its insurance rates or prevent it from securing insurance coverage in the future. Additionally, any product liability lawsuit could cause injury to DermTech’s reputation or cause it to suspend sales of its product. The occurrence of any of these events could have an adverse effect on DermTech’s business results of operations.

Intellectual Property Risks Related to DermTech’s Business

DermTech’s collaborators may assert ownership or commercial rights to inventions DermTech develops from DermTech’s use of the biological materials which they provide to DermTech, or otherwise arising from the collaboration.

DermTech collaborates with several institutions, physicians, and researchers in scientific matters. Also, DermTech relies on numerous third parties to provide it with adhesive patch samples and biological materials that DermTech uses to develop tests. If DermTech cannot successfully negotiate sufficient ownership, licensing, and/or commercial rights to any inventions that result from its use of a third-party collaborator’s materials, or if disputes arise with respect to the intellectual property developed with the use of a collaborator’s samples, or data developed in a collaborator’s study, DermTech’s ability to capitalize on the market potential of these inventions or developments may be limited or precluded altogether.

If DermTech is unable to maintain intellectual property protection, DermTech’s competitive position could be harmed.

DermTech’s ability to protect its discoveries and technologies affects its ability to compete and to achieve sustained profitability. Currently, DermTech relies on a combination of U.S. and foreign patents and patent applications, copyrights, trademarks and trademark applications, confidentiality or non-disclosure agreements, material transfer agreements, licenses, consulting agreements, work-for-hire agreements, and invention assignment agreements to protect DermTech’s intellectual property rights. DermTech also maintains certain company know-how, trade secrets, and technological innovations designed to provide DermTech with a competitive advantage in the marketplace as trade secrets. Currently, DermTech owns five issued U.S. patents, four pending U.S. patent applications, and their corresponding foreign counterpart patents and patent applications, relevant to DermTech’s testing methodology and expression profiles. While DermTech intends to pursue additional patent applications, it is possible that DermTech’s pending patent applications and any future applications may not result in issued patents. Even if patents are issued, third parties may independently develop similar or competing technology that avoids DermTech’s patents. Further, DermTech cannot be certain that the steps it has taken will prevent the misappropriation of DermTech’s trade secrets and other confidential information as well as the misuse of DermTech’s patents and other intellectual property, particularly in foreign countries where DermTech has not filed for patent protection.

From time-to-time the U.S. Supreme Court, other federal courts, the USPTO, may change the standards of patentability and any such changes could have a negative impact on DermTech’s business. For instance, in 2008, the Court of Appeals for the Federal Circuit issued a decision that methods or processes cannot be patented

 

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unless they are tied to a machine or involve a physical transformation. The U.S. Supreme Court later reversed that decision in Bilski v. Kappos , finding that the “machine-or-transformation” test is not the only test for determining patent eligibility. The Court, however, declined to specify how and when processes are patentable. In 2012, in the case Mayo Collaborative Services v. Prometheus Laboratories, Inc. , the U.S. Supreme Court reversed the Federal Circuit’s application of Bilski and invalidated a patent focused on a diagnostic process because the patent claim embodied a law of nature.

In 2013, in Association for Molecular Pathology v. Myriad Genetics , the Supreme Court unanimously ruled that, “[a] naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated,” thereby invalidating Myriad Genetics’ patents on the BRCA1 and BRCA2 breast cancer genes. However, the Supreme Court also held that manipulation of a gene to create something not found in nature, such as a strand of synthetically-produced complementary DNA, or cDNA, could still be eligible for patent protection. The Supreme Court noted that method patents, which concern technical procedures for carrying out a certain process, are not affected by the ruling.

More recently, the Federal Circuit has ruled on several patent cases – such as Univ. of Utah Research Found. v. Ambry Genetics Corp. , 774 F.3d 755 (Fed. Cir. 2014),  Ariosa Diagnostics, Inc. v. Sequenom, Inc. , 788 F.3d 1371 (Fed. Cir. 2015),  Genetic Tech. Ltd. v. Merial LLC , 818 F.3d 1369 (Fed. Cir. 2016), and  Cleveland Clinic Found. v. True Health Diagnostics , 859 F.3d 1352 (Fed. Cir. 2017) – that some diagnostic method claims are patent ineligible. These decisions have narrowed the scope of patent protection available in certain circumstances or weakened the rights of patent owners in certain situations. Some aspects of DermTech’s technology involve processes that may be subject to this evolving standard and DermTech cannot guarantee that any of its pending process claims will be patentable as a result of such evolving standards. In addition, this combination of decisions has created uncertainty as to the value of certain issued patents, in particular patents in the molecular biology analysis and diagnostic space. Moreover, there is additional uncertainty around the evolving standard in light of the USPTO Revised Patent Subject Matter Eligibility Guidance issued in Jan. 2019.

It should also be noted that in 2010, the Secretary’s Advisory Committee on Genetics, Health and Society voted to approve a report entitled “ Gene Patents and Licensing Practices and Their Impact on Patient Access to Genetic Tests .” That report defines “patent claims on genes” broadly to include claims to isolated nucleic acid molecules as well as methods of detecting particular sequences or mutations. The report also contains six recommendations, including the creation of an exemption from liability for infringement of patent claims on genes for anyone making, using, ordering, offering for sale, or selling a test developed under the patent for patient care purposes, or for anyone using the patent-protected genes in the pursuit of research. The report also recommended that HHS should explore, identify, and implement mechanisms that will encourage more voluntary adherence to current guidelines that promote nonexclusive in-licensing of diagnostic genetic and genomic technologies. It is unclear whether HHS will act upon these recommendations, or if the recommendations would result in a change in law or process that could negatively impact DermTech’s patent portfolio or future research and development efforts. If acted upon, implementation of such provisions could have a material negative impact on DermTech’s business.

DermTech may face intellectual property infringement claims that could be time-consuming and costly to defend, and could result in the loss of significant rights, the implementation of an injunction, and the assessment of treble damages.

From time-to-time DermTech may face intellectual property infringement or misappropriation claims from third parties. Some of these claims may lead to litigation. The outcome of any such litigation can never be guaranteed, and an adverse outcome could affect DermTech negatively. For example, were a third party to succeed on an infringement claim against DermTech, it may be required to pay substantial damages, including treble damages if such infringement were found to be willful. In addition, DermTech could face an injunction barring DermTech from conducting the allegedly infringing activity, including an order preventing DermTech from offering its current tests and future planned tests in the marketplace. The outcome of the litigation could require it to enter

 

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into a license agreement which may not be pursuant to acceptable or commercially reasonable or practical terms or which may not be available at all.

It is also possible that an adverse finding of infringement against DermTech may require it to dedicate substantial resources and time in developing non-infringing alternatives, which may or may not be possible. In the case of diagnostic tests, DermTech would also need to include non-infringing technologies, which would require DermTech to re-validate the test. Any such re-validation, in addition to being costly and time-consuming, may be unsuccessful. Finally, DermTech may initiate claims to assert or defend its own intellectual property against third parties. Any intellectual property litigation, irrespective of whether DermTech is the plaintiff or the defendant, and regardless of the outcome, is expensive and time-consuming, and could divert and distract DermTech’s management’s attention from its business and negatively affect its operating results or financial condition.

Changes in health care policy could increase DermTech’s costs, decrease its revenues and impact sales of and reimbursement for its tests.

In March 2010, the ACA, became law. This law substantially changed the way health care is financed by both commercial payers and government payers, and significantly impacted DermTech’s industry. Since 2016 there have been efforts to repeal all or part of the ACA, and the current Presidential Administration and the U.S. Congress have taken action to roll back certain provisions of the ACA. For example, the Tax Cuts and Jobs Act, among other things, removes penalties for not complying with the ACA’s individual mandate to carry health insurance. The current Presidential Administration and the U.S. Congress may take further action regarding the ACA, including, but not limited to, repeal or replacement. Additionally, all or a portion of the ACA and related subsequent legislation may be modified, repealed or otherwise invalidated through judicial challenge, which could result in lower numbers of insured individuals, reduced coverage for insured individuals and adversely affect DermTech’s business. The ACA contained a number of provisions expected to impact DermTech’s business and operations, some of which in ways DermTech cannot currently predict, including those governing enrollment in state and federal health care programs, reimbursement changes and fraud and abuse, which will impact existing state and federal health care programs and will result in the development of new programs. For instance, the ACA required each medical device manufacturer to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its medical devices, and began to apply to sales of taxable medical devices after December 31, 2012. Through a series of legislative amendments, the tax was suspended for 2016 through 2019. Absent further legislative action, the device excise tax will be reinstated on medical device sales starting January 1, 2020. The taxes imposed by the ACA and the expansion in the government’s role in the U.S. healthcare industry may result in decreased profits to DermTech and lower reimbursement by payers for DermTech’s tests, any of which may have a material adverse impact on DermTech’s business, financial condition, results of operations or cash flows. In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, reduced Medicare payments to providers by 2% per fiscal year, effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2027 unless additional Congressional action is taken. DermTech anticipates there will continue to be proposals by legislators at both the federal and state levels, regulators and commercial payers to reduce costs while expanding individual healthcare benefits. Certain of these changes could impose additional limitations on the prices DermTech will be able to charge for its tests, the coverage of or the amounts of reimbursement available for DermTech’s tests from payers, including commercial payers and government payers.

U.S. healthcare reform

In the United States, there have been a number of legislative and regulatory changes at the federal and state levels which seek to reduce healthcare costs and improve the quality of healthcare. For example, in March 2010, the ACA, became law. This law substantially changed the way health care is financed by both commercial payers and government payers, and significantly impacted DermTech’s industry. Since 2016 there have been efforts to repeal all or part of the ACA, and the current Presidential Administration and U.S. Congress have taken action to

 

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roll certain provisions of the ACA. For example, the Tax Cuts and Jobs Act, among other things, removes penalties for not complying with the ACA’s individual mandate to carry health insurance. The current Presidential Administration and the U.S. Congress may take further action regarding the ACA, including, but not limited to, repeal or replacement. Additionally, all or a portion of the ACA and related subsequent legislation may be modified, repealed or otherwise invalidated through judicial challenge, which could result in lower numbers of insured individuals, reduced coverage for insured individuals and adversely affect DermTech’s business. The ACA contained a number of provisions expected to impact DermTech’s business and operations, some of which in ways DermTech cannot currently predict, including those governing enrollment in state and federal health care programs, reimbursement changes and fraud and abuse, which will impact existing state and federal health care programs and will result in the development of new programs. For instance, the ACA required each medical device manufacturer to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its medical devices, and began to apply to sales of taxable medical devices after December 31, 2012. Through a series of legislative amendments, the tax was suspended for 2016 through 2019. Absent further legislative action, the device excise tax will be reinstated on medical device sales starting January 1, 2020. The taxes imposed by the ACA and the expansion in the government’s role in the U.S. healthcare industry may result in decreased profits to DermTech and lower reimbursement by payers for DermTech’s tests, any of which may have a material adverse impact on its business, financial condition, results of operations or cash flows. In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, reduced Medicare payments to providers by 2% per fiscal year, effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2027 unless additional Congressional action is taken. DermTech anticipates there will continue to be proposals by legislators at both the federal and state levels, regulators and commercial payers to reduce costs while expanding individual healthcare benefits. Certain of these changes could impose additional limitations on the prices DermTech will be able to charge for its tests, the coverage of or the amounts of reimbursement available for its tests from payers, including commercial payers and government payers.

Tax Risks Related to DermTech’s Business

DermTech’s ability to use its net operating losses to offset future taxable income may be subject to certain limitations.

In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its carryforwards to offset future taxable income. DermTech’s existing net operating loss carryforwards, or NOLs, may be subject to limitations arising from previous ownership changes, and if DermTech undergoes an ownership change in connection with or after a merger transaction, DermTech’s ability to utilize NOLs could be further limited by Section 382 of the Code. Future changes in DermTech’s stock ownership, some of which are outside of DermTech’s control, could result in an ownership change under Section 382 of the Code. There is also a risk that due to regulatory changes, such as suspensions on the use of NOLs, or other unforeseen reasons, DermTech’s existing and any future NOLs could expire or otherwise be unavailable to offset future income tax liabilities. DermTech has not conducted a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since inception due to the significant complexity and cost associated with such a study.

The recently passed comprehensive tax reform bill could adversely affect DermTech’s business and financial condition.

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, or the TCJA, that significantly reforms the Code. The TCJA, among other things, contains significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation on the deductibility of interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of current year taxable income and

 

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elimination of net operating loss carrybacks, one time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, reduction or elimination of U.S. tax on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. The overall impact of the TCJA is uncertain and DermTech’s business and financial condition could be adversely affected. The impact of this tax reform on holders of the combined company’s common stock is also uncertain and could be adverse. You are urged to consult with your legal and tax advisors with respect to such legislation and the potential tax consequences of investing in the combined company’s common stock.

Risks Related to Constellation’s Business and the Business Combination

Subsequent to the consummation of the business combination, Constellation may be required to take writedowns or write-offs, restructuring and impairment or other charges that could have a significant negative effect on Constellation’s financial condition, results of operations and ordinary share price, which could cause you to lose some or all of your investment.

Although Constellation has conducted due diligence on DermTech, Constellation cannot assure you that this diligence revealed all material issues that may be present in DermTech’s business, that it would be possible to uncover all material issues through a customary amount of due diligence, or that factors outside of Constellation’s and DermTech’s control will not later arise. As a result, Constellation may be forced to later writedown or write-off assets, restructure its operations, or incur impairment or other charges that could result in losses. Even if Constellation’s due diligence successfully identified certain risks, unexpected risks may arise and previously known risks may materialize in a manner not consistent with Constellation’s preliminary risk analysis. Even though these charges may be non-cash items and not have an immediate impact on Constellation’s liquidity, the fact that Constellation reports charges of this nature could contribute to negative market perceptions about it or its securities. In addition, charges of this nature may cause Constellation to be unable to obtain future financing on favorable terms or at all.

There can be no assurance that the combined company’s common stock will be approved for listing on Nasdaq following the Closing or that the combined company will be able to comply with the continued listing standards of Nasdaq.

In connection with the closing of the business combination, Constellation intends to list the combined company’s common stock and warrants on Nasdaq under the symbols “DMTK” and “DMTKW,” respectively. The combined company’s continued eligibility for listing may depend on the number of Constellation’s ordinary shares that are redeemed. If, after the business combination, Nasdaq delists the combined company’s shares from trading on its exchange for failure to meet the listing standards, the combined company and its stockholders could face significant material adverse consequences including:

 

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a limited availability of market quotations for the combined company’s securities;

 

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a determination that the combined company’s common stock is a “penny stock” which will require brokers trading in the combined company’s common stock to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for shares of the combined company’s common stock;

 

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a limited amount of analyst coverage; and

 

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a decreased ability to issue additional securities or obtain additional financing in the future.

If the business combination’s benefits do not meet the expectations of investors or securities analysts, the market price of the combined company’s securities may decline.

If the benefits of the business combination do not meet the expectations of investors or securities analysts, the market price of the combined company’s securities prior to the Closing may decline. The market values of the

 

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combined company’s securities at the time of the business combination may vary significantly from their prices on the date the Merger Agreement was executed, the date of this proxy statement/prospectus/information statement, or the date on which Constellation’s shareholders vote on the business combination.

In addition, following the business combination, fluctuations in the price of the combined company’s securities could contribute to the loss of all or part of your investment. Prior to the business combination, there has not been a public market for DermTech’s capital stock. Accordingly, the valuation ascribed to DermTech may not be indicative of the price that will prevail in the trading market following the business combination. If an active market for the combined company’s securities develops and continues, the trading price of the combined company’s securities following the business combination could be volatile and subject to wide fluctuations in response to various factors, some of which are beyond the combined company’s control. Any of the factors listed below could have a material adverse effect on your investment in the combined company’s securities and the combined company’s securities may trade at prices significantly below the price you paid for them. In such circumstances, the trading price of the combined company’s securities may not recover and may experience a further decline.

Factors affecting the trading price of the combined company’s securities may include:

 

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actual or anticipated fluctuations in the combined company’s quarterly financial results or the quarterly financial results of companies perceived to be similar to it;

 

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changes in the market’s expectations about the combined company’s operating results;

 

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success of competitors;

 

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the combined company’s operating results failing to meet the expectation of securities analysts or investors in a particular period;

 

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changes in financial estimates and recommendations by securities analysts concerning the combined company or the medical diagnostic industry in general;

 

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operating and share price performance of other companies that investors deem comparable to the combined company;

 

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the combined company’s ability to market new and enhanced products on a timely basis;

 

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changes in laws and regulations affecting the combined company’s business;

 

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the combined company’s ability to meet compliance requirements;

 

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commencement of, or involvement in, litigation involving the combined company;

 

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changes in the combined company’s capital structure, such as future issuances of securities or the incurrence of additional debt;

 

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the volume of the combined company’s shares of common stock available for public sale;

 

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any major change in the combined company’s board of directors or management;

 

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sales of substantial amounts of the combined company’s shares of common stock by the combined company’s directors, executive officers or significant shareholders or the perception that such sales could occur; and

 

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general economic and political conditions such as recessions, interest rates, fuel prices, international currency fluctuations and acts of war or terrorism.

Broad market and industry factors may materially harm the market price of the combined company’s securities irrespective of the combined company’s operating performance. The stock market in general, and Nasdaq in particular, have experienced price and volume fluctuations that have often been unrelated or disproportionate to

 

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the operating performance of the particular companies affected. The trading prices and valuations of these stocks, and of the combined company’s securities, may not be predictable. A loss of investor confidence in the market for retail stocks or the stocks of other companies which investors perceive to be similar to the combined company could depress the combined company’s share price regardless of the combined company’s business, prospects, financial conditions or results of operations. A decline in the market price of the combined company’s securities also could adversely affect the combined company’s ability to issue additional securities and the combined company’s ability to obtain additional financing in the future.

Following the consummation of the business combination, the combined company will incur significant increased expenses and administrative burdens as a public company, which could have an adverse effect on its business, financial condition and results of operations.

Following the consummation of the business combination, the combined company will face increased legal, accounting, administrative and other costs and expenses as a public company that DermTech does not incur as a private company. The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, including the requirements of Section 404, as well as rules and regulations subsequently implemented by the SEC, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated and to be promulgated thereunder, the PCAOB and the securities exchanges, impose additional reporting and other obligations on public companies. Compliance with public company requirements will increase costs and make certain activities more time-consuming. A number of those requirements will require the combined company to carry out activities DermTech has not done previously. For example, the combined company will create new board committees and adopt new internal controls and disclosure controls and procedures. In addition, additional expenses associated with SEC reporting requirements will be incurred. Furthermore, if any issues in complying with those requirements are identified (for example, if the auditors identify a material weakness or significant deficiency in the internal control over financial reporting), the combined company could incur additional costs rectifying those issues, and the existence of those issues could adversely affect the combined company’s reputation or investor perceptions of it. It may also be more expensive to obtain director and officer liability insurance. Risks associated with the combined company’s status as a public company may make it more difficult to attract and retain qualified persons to serve on the board of directors or as executive officers. The additional reporting and other obligations imposed by these rules and regulations will increase legal and financial compliance costs and the costs of related legal, accounting and administrative activities. These increased costs will require the combined company to divert a significant amount of money that could otherwise be used to expand the business and achieve strategic objectives. Advocacy efforts by shareholders and third parties may also prompt additional changes in governance and reporting requirements, which could further increase costs.

The combined company’s failure to timely and effectively implement controls and procedures required by Section 404(a) of the Sarbanes-Oxley Act that will be applicable to it after the business combination is consummated could have a material adverse effect on its business.

DermTech is not currently subject to Section 404 of the Sarbanes-Oxley Act. However, following the consummation of the business combination, the combined company will be required to provide management’s attestation on internal controls. The standards required for a public company under Section 404(a) of the Sarbanes-Oxley Act are significantly more stringent than those required of DermTech as a privately-held company. Management may not be able to effectively and timely implement controls and procedures that adequately respond to the increased regulatory compliance and reporting requirements that will be applicable after the business combination. If the combined company is not able to implement the additional requirements of Section 404(a) in a timely manner or with adequate compliance, it may not be able to assess whether its internal controls over financial reporting are effective, which may subject it to adverse regulatory consequences and could harm investor confidence and the market price of its securities.

 

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The combined company will qualify as an emerging growth company within the meaning of the Securities Act of 1933, as amended, or the Securities Act, and if it takes advantage of certain exemptions from disclosure requirements available to emerging growth companies, which could make the Combined Company’s securities less attractive to investors and may make it more difficult to compare the combined company’s performance to the performance of other public companies.

The combined company will qualify as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the Jumpstart Our Business Startups, or JOBS Act. As such, the combined company will be eligible for and intends to take advantage of certain exemptions from various reporting requirements applicable to other public companies that are not emerging growth companies for as long as it continues to be an emerging growth company, including (i) the exemption from the auditor attestation requirements with respect to internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act, (ii) the exemptions from say-on-pay, say-on-frequency and say-on-golden parachute voting requirements and (iii) reduced disclosure obligations regarding executive compensation in its periodic reports and proxy statements. The combined company will remain an emerging growth company until the earliest of (i) the last day of the fiscal year in which the market value of its ordinary shares that are held by non-affiliates exceeds $700 million as of June 30 of that fiscal year, (ii) the last day of the fiscal year in which it has total annual gross revenue of $1.07 billion or more during such fiscal year (as indexed for inflation), (iii) the date on which it has issued more than $1 billion in non-convertible debt in the prior three-year period or (iv) the last day of the fiscal year following the fifth anniversary of the date of the first sale of Constellation’s ordinary shares in its initial public offering. In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the exemption from complying with new or revised accounting standards provided in Section 7(a)(2)(B) of the Securities Act as long as the combined company is an emerging growth company. An emerging growth company can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. Constellation has elected not to opt out of such extended transition period and, therefore, the combined company may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. Investors may find the ordinary shares less attractive because the combined company will rely on these exemptions, which may result in a less active trading market for the ordinary shares and their price may be more volatile.

The unaudited pro forma financial information included herein may not be indicative of what the combined company’s actual financial position or results of operations would have been.

The unaudited pro forma financial information included herein is presented for illustrative purposes only and is not necessarily indicative of what the combined company’s actual financial position or results of operations would have been had the business combination been completed on the dates indicated.

DermTech’s management has limited experience in operating a public company.

DermTech’s executive officers have limited experience in the management of a publicly traded company. DermTech’s management team may not successfully or effectively manage its transition to a public company following the business combination that will be subject to significant regulatory oversight and reporting obligations under federal securities laws. Their limited experience in dealing with the increasingly complex laws pertaining to public companies could be a significant disadvantage in that it is likely that an increasing amount of their time may be devoted to these activities which will result in less time being devoted to the management and growth of the combined company. DermTech currently may not have a complement of personnel with the appropriate level of knowledge, experience, and training in the accounting policies, practices or internal controls over financial reporting required of public companies in the United States and U.S. GAAP. The development and implementation of the standards and controls necessary for the combined company to achieve the level of accounting standards required of a public company in the United States may require costs greater than expected. It is possible that the combined company will be required to expand its employee base and hire additional employees to support its operations as a public company which will increase its operating costs in future periods.

 

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Constellation’s sponsor has agreed to vote in favor of the business combination, regardless of how Constellation’s public shareholders vote.

Unlike many other blank check companies in which the initial shareholders agree to vote their Founder Shares in accordance with the majority of the votes cast by the public shareholders in connection with an initial business combination, Constellation’s sponsor has agreed to vote its Founder Shares, as well as any public shares purchased during or after Constellation’s initial public offering, in favor of the business combination. Constellation’s sponsor owns approximately 72.7% of the outstanding ordinary shares. Accordingly, it is more likely that the necessary shareholder approval to complete the business combination will be received than would be the case if Constellation’s initial shareholders agreed to vote their Founder Shares in accordance with the majority of the votes cast by Constellation’s public shareholders.

If Constellation is not able to complete its initial business combination by September 23, 2019, it will cease all operations except for the purpose of winding up and Constellation will redeem its public shares and liquidate, in which case the warrants and rights will expire worthless.

Constellation’s memorandum and articles of association provide that Constellation must complete an initial business combination before September 23, 2019. Constellation may not be able to consummate an initial business combination within such time period. Constellation’s ability to complete its initial business combination may be negatively impacted by general market conditions, volatility in the capital and debt markets and the other risks described herein.

If Constellation is unable to consummate its initial business combination by September 23, 2019 and Constellation’s shareholders have not approved a further extension by such date, Constellation will, as promptly as reasonably possible but not more than five business days thereafter, distribute the aggregate amount then on deposit in the trust account (net of taxes payable, and less up to $50,000 of interest to pay liquidation expenses), pro rata to the public shareholders by way of redemption and cease all operations except for the purposes of winding up of its affairs. This redemption of public shareholders from the Trust Account shall be effected as required by function of Constellation’s memorandum and articles of association and prior to any voluntary winding up. In the event of liquidation, there will be no distribution with respect to Constellation’s outstanding warrants. Accordingly, the warrants will expire worthless. If Constellation is unable to complete an initial business combination within the required time period and Constellation redeems the public shares for the funds held in the trust account, holders of rights will not receive any such funds in exchange for their rights and the rights will expire worthless.

For illustrative purposes, based on funds in the Trust Account of approximately $12.4 million on May 28, 2019, the estimated per share redemption price would have been approximately $10.45.

Constellation’s sponsor, directors, officers, advisors or their affiliates may elect to purchase shares from public shareholders, which may influence the vote on the business combination and reduce the public “float” of ordinary shares.

Constellation’s sponsor, directors, officers, advisors or their affiliates may purchase ordinary shares in privately negotiated transactions or in the open market either prior to or following the completion of the business combination, although they are under no obligation to do so. Such a purchase may include a contractual acknowledgement that such shareholder, although still the record holder of such shares, is no longer the beneficial owner thereof and therefore agrees not to exercise its redemption rights. In the event that Constellation’s sponsor and Constellation’s directors, officers, advisors or their affiliates purchase shares in privately negotiated transactions from public shareholders who have already elected to exercise their redemption rights, such selling shareholders would be required to revoke their prior elections to redeem their shares. The purpose of such purchases could be to vote such shares in favor of the business combination and thereby increase the likelihood of obtaining shareholder approval of the business combination. This may result in the completion of the business combination that may not otherwise have been possible.

 

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In addition, if such purchases are made, the public “float” of the ordinary shares and the number of beneficial holders of the combined company’s securities may be reduced, possibly making it difficult for the combined company to obtain the quotation, listing or trading of its securities on a national securities exchange.

Constellation’s ability to successfully effect the business combination and successfully operate the business thereafter will be largely dependent upon the efforts of certain key personnel of DermTech, all of whom Constellation expects to stay with the combined company following the business combination. The loss of such key personnel could negatively impact the operations and profitability of the combined business.

Constellation’s ability to successfully effect the business combination and successfully operate the business is dependent upon the efforts of certain key personnel of DermTech. Although Constellation expects all of such key personnel to remain with the combined company following the business combination, there can be no assurance that they will do so. It is possible that DermTech will lose some key personnel, the loss of which could negatively impact the operations and profitability of the combined company. Furthermore, following the closing of the business combination, certain of the key personnel of DermTech may be unfamiliar with the requirements of operating a company regulated by the SEC, which could cause the combined company to have to expend time and resources helping them become familiar with such requirements.

Constellation’s board of directors did not obtain a fairness opinion in determining whether or not to proceed with the business combination and, as a result, the terms may not be fair from a financial point of view to Constellation’s public shareholders.

In analyzing the business combination, the Constellation’s board of directors conducted significant due diligence on DermTech. For a complete discussion of the factors utilized by Constellation’s board of directors in approving the business combination, see the section entitled, “ The Business Combination – Constellation Reasons for the Business Combination. ” The Constellation board of directors believes because of the financial skills and background of its directors, it was qualified to conclude that the business combination was fair from a financial perspective to its shareholders and that DermTech’s fair market value was at least 80% of Constellation’s net assets (excluding deferred underwriting discounts and commissions). Notwithstanding the foregoing, Constellation’s board of directors did not obtain a fairness opinion to assist it in its determination. Accordingly, Constellation’s board of directors may be incorrect in its assessment of the business combination.

The ability of Constellation’s public shareholders to exercise redemption rights with respect to a large number of ordinary shares could increase the probability that the business combination will be unsuccessful and that Constellation’s shareholders will have to wait for liquidation in order to redeem their public shares.

Since the Merger Agreement requires that Constellation has at least $15,000,000 at the Closing, the probability that the business combination will be unsuccessful is increased if a large number of public shares are tendered for redemption and Constellation is unable to raise enough additional funds to satisfy this requirement. If the business combination is unsuccessful, public shareholders will not receive their pro rata portion of the Trust Account until the Trust Account is liquidated. If public shareholders are in need of immediate liquidity, they could attempt to sell their public shares in the open market; however, at such time, the ordinary shares may trade at a discount to the pro rata per share amount in the Trust Account. In either situation, Constellation’s shareholders may suffer a material loss on their investment or lose the benefit of funds expected in connection with the redemption until Constellation is liquidated or Constellation’s shareholders are able to sell their public shares in the open market.

If a shareholder fails to comply with the procedures for tendering its public shares in connection with the business combination, such shares may not be redeemed.

This proxy statement/prospectus/information statement describes the various procedures that must be complied with in order for a shareholder to validly redeem its public shares. In the event that a shareholder fails to comply with these procedures, its shares may not be redeemed.

 

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Constellation’s public shareholders will not have any rights or interests in funds from the Trust Account, except under certain limited circumstances. To liquidate their investment, therefore, public shareholders may be forced to sell their public shares, rights or warrants, potentially at a loss.

Constellation’s public shareholders will be entitled to receive funds from the Trust Account only (i) in the event of a redemption of the public shares prior to any winding up in the event Constellation does not consummate its initial business combination by September 23, 2019, (ii) if they redeem their shares in connection with an initial business combination that Constellation consummates or (iii) if they redeem their shares in connection with a shareholder vote to amend Constellation’s amended and restated memorandum and articles of association (A) to modify the substance or timing of Constellation’s obligation to redeem 100% of Constellation’s public shares if Constellation does not complete its initial business combination by September 23, 2019 or (B) with respect to any other provision relating to shareholders’ rights or pre-business combination activity. In addition, if Constellation is unable to complete an initial business combination by September 23, 2019 for any reason, compliance with British Virgin Islands law may require that Constellation submit a plan of liquidation to its shareholders for approval prior to the distribution of the proceeds held in the Trust Account. In that case, public shareholders may be forced to wait beyond September 23, 2019 before they receive funds from the Trust Account. In no other circumstances will a public shareholder have any right or interest of any kind in the Trust Account. Accordingly, to liquidate your investment, you may be forced to sell your public shares, rights or warrants, potentially at a loss.

If a shareholder or a “group” of shareholders are deemed to hold in excess of 20% of the public shares, such shareholder or group will lose the ability to redeem all such public shares in excess of 20% of the public shares.

Constellation’s memorandum and articles of association provide that a public shareholder, together with any affiliate of such shareholder or any other person with whom such shareholder is acting in concert or as a “group” (as defined under Section 13 of the Securities Exchange Act of 1934, as amended, or the Exchange Act), will be restricted from seeking redemption rights with respect to more than an aggregate of 20% of the public shares, which we refer to as the Excess Shares. However, Constellation would not be restricting its shareholders’ ability to vote all of their ordinary shares (including Excess Shares) for or against a business combination. The inability of a shareholder to redeem the Excess Shares will reduce its influence over Constellation’s ability to complete a business combination and such shareholder could suffer a material loss on its investment in Constellation if it sells Excess Shares in open market transactions. Additionally, such shareholder will not receive redemption distributions with respect to the Excess Shares if Constellation completes a business combination. And as a result, such shareholder will continue to hold that number of shares exceeding 20% and, in order to dispose of such shares, would be required to sell its shares in open market transactions, potentially at a loss.

Public shareholders who purchased units in Constellation’s initial public offering and do not exercise their redemption rights may pursue rescission rights and related claims.

Constellation’s public shareholders may allege that some aspects of the business combination are inconsistent with the disclosure contained in the prospectus issued by Constellation in connection with the offer and sale of units in its initial public offering, including the structure of the proposed business combination. Consequently, a public shareholder who purchased units in Constellation’s initial public offering (excluding the initial shareholders) and still holds them at the time of the business combination and who does not seek to exercise redemption rights, might seek rescission of the purchase of the units such holder acquired in Constellation’s initial public offering. A successful claimant for damages under applicable law could be awarded an amount to compensate for the decrease in the value of such holder’s shares caused by the alleged violation (including, possibly, punitive damages), together with interest, while retaining the shares. If shareholders bring successful rescission claims against the combined company, it may not have sufficient funds following the consummation of the business combination to pay such claims, or if claims are successfully brought against the combined company following the consummation of the business combination, the combined company’s results of operations could

 

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be adversely affected and, in any event, the combined company may be required in connection with the defense of such claims to incur expenses and divert employee attention from other business matters.

If third parties bring claims against Constellation, the proceeds held in the Trust Account could be reduced and the per-share redemption amount received by shareholders may be less than $10.10 per share.

Constellation’s placing of funds in the Trust Account may not protect those funds from third-party claims against Constellation. Although Constellation seeks to have all vendors, service providers (other than Constellation’s independent auditors), prospective target businesses and other entities with which Constellation does business execute agreements with Constellation waiving any right, title, interest or claim of any kind in or to any monies held in the Trust Account for the benefit of the public shareholders, such parties may not execute such agreements, or even if they execute such agreements they may not be prevented from bringing claims against the Trust Account, including, but not limited to, fraudulent inducement, breach of fiduciary responsibility or other similar claims, as well as claims challenging the enforceability of the waiver, in each case in order to gain advantage with respect to a claim against Constellation’s assets, including the funds held in the Trust Account. If any third-party refuses to execute an agreement waiving such claims to the monies held in the Trust Account, Constellation’s management will perform an analysis of the alternatives available to it and will only enter into an agreement with a third-party that has not executed a waiver if management believes that such third-party’s engagement would be significantly more beneficial to Constellation than any alternative.

Examples of possible instances where Constellation may engage a third-party that refuses to execute a waiver include the engagement of a third-party consultant whose particular expertise or skills are believed by management to be significantly superior to those of other consultants that would agree to execute a waiver or in cases where management is unable to find a service provider willing to execute a waiver. In addition, there is no guarantee that such entities will agree to waive any claims they may have in the future as a result of, or arising out of, any negotiations, contracts or agreements with Constellation and will not seek recourse against the Trust Account for any reason. Upon redemption of Constellation’s public shares, if Constellation is unable to complete its business combination within the prescribed timeframe, or upon the exercise of a redemption right in connection with Constellation’s business combination, Constellation will be required to provide for payment of claims of creditors that were not waived that may be brought against Constellation within the 10 years following redemption. Accordingly, the per-share redemption amount received by public shareholders could be less than the $10.10 per share initially held in the Trust Account, due to claims of such creditors. In order to protect the amounts held in the Trust Account, Constellation’s sponsor agreed to be liable to Constellation if and to the extent any claims by a vendor for services rendered or products sold to Constellation, or a prospective target business with which Constellation has discussed entering into a transaction agreement, reduce the amount of funds in the Trust Account. This liability will not apply with respect to any claims by a third-party who executed a waiver of any and all rights to seek access to the Trust Account and except as to any claims under Constellation’s indemnity of the underwriters of Constellation’s initial public offering against certain liabilities, including liabilities under the Securities Act. Moreover, in the event that an executed waiver is deemed to be unenforceable against a third-party, then Constellation’s sponsor will not be responsible to the extent of any liability for such third-party claims. Constellation has not independently verified whether its sponsor has sufficient funds to satisfy its indemnity obligations. Therefore, Constellation cannot assure you that its sponsor would be able to satisfy those obligations.

If, before distributing the proceeds in the Trust Account to the public shareholders, Constellation files a bankruptcy petition or an involuntary bankruptcy petition is filed against Constellation that is not dismissed, the claims of creditors in such proceeding may have priority over the claims of Constellation’s shareholders and the per-share amount that would otherwise be received by the public shareholders in connection with Constellation’s liquidation may be reduced.

If, before distributing the proceeds in the Trust Account to the public shareholders, Constellation files a bankruptcy petition or an involuntary bankruptcy petition is filed against Constellation that is not dismissed, the

 

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proceeds held in the Trust Account could be subject to applicable bankruptcy law, and may be included in Constellation’s bankruptcy estate and subject to the claims of third parties with priority over the claims of Constellation’s public shareholders. To the extent any bankruptcy claims deplete the Trust Account, the per-share amount that would otherwise be received by Constellation’s public shareholders in connection with Constellation’s liquidation may be reduced.

Future issuances of equity securities may dilute the interests of Constellation’s shareholders and reduce the price of Constellation’s securities.

Any future issuance of Constellation’s equity securities, such as the PIPE, could dilute the interests of Constellation’s then existing shareholders and could substantially decrease the trading price of Constellation’s securities. Constellation may issue equity or equity-linked securities in connection with the business combination or in the future, including pursuant to a private investment in public equity, or PIPE, or other offering of equity securities, for a number of reasons, including to finance Constellation’s operations and business strategy (including in connection with acquisitions and other transactions), to adjust Constellation’s ratio of debt to equity, to satisfy its obligations upon the exercise of then-outstanding options or other equity-linked securities, if any, or for other reasons.

Constellation’s sponsor, executive officers and directors have potential conflicts of interest in recommending that shareholders vote in favor of approval of the Business Combination Proposal and approval of the other proposals described in this proxy statement/prospectus/information statement.

When you consider the recommendation of Constellation’s board of directors in favor of approval of the Business Combination Proposal, you should keep in mind that certain of Constellation’s directors and officers have interests in the business combination that are different from, or in addition to, your interests as a shareholder. These interests include, among other things:

 

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the beneficial ownership of Constellation’s sponsor and directors of an aggregate of 3,882,500 ordinary shares, which shares would become worthless if Constellation does not complete a business combination within the applicable time period, as Constellation’s initial shareholders have waived any right to redemption with respect to these ordinary shares. Such shares have an aggregate market value of approximately $40,145,050 based on the closing price of the ordinary shares of $10.34 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders;

 

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the beneficial ownership of Constellation’s sponsor and directors of warrants to purchase 212,500 ordinary shares, which warrants would expire and become worthless if Constellation does not complete a business combination within the applicable time period. Such warrants have an aggregate market value of approximately $10,625 based on the closing price of Constellation’s warrants of $0.05 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders;

 

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the beneficial ownership of Constellation’s sponsor and directors of rights to receive 42,500 ordinary shares, which rights will become worthless if Constellation does not complete a business combination within the applicable time period. Such rights have an aggregate market value of approximately $8,075 based on the closing price of Constellation’s rights of $0.19 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders; and

 

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as of                , 2019, Constellation’s initial shareholders have advanced approximately $            to Constellation for operating expenses. Such advances will be repaid only if Constellation completes a business combination.

These interests may influence Constellation’s directors in making their recommendation that you vote in favor of the Business Combination Proposal and the other proposals described in this proxy statement/prospectus/information statement. You should also read the section entitled “ The Business Combination – Constellation Reasons for the Business Combination .”

 

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Constellation may amend the terms of the warrants in a manner that may be adverse to holders with the approval by the holders of a majority of the then outstanding warrants. As a result, the exercise price of your warrants could be increased, the exercise period could be shortened and the number of ordinary shares purchasable upon exercise of a warrant could be decreased, all without your approval.

The warrants are subject to the warrant agreement, dated June 19, 2017, between Constellation and Continental Stock Transfer & Trust Company, as warrant agent. The warrant agreement provides that the terms of the warrants may be amended without the consent of any holder to cure any ambiguity or correct any defective provision, but requires the approval by the holders of a majority of the then outstanding warrants to make any change that adversely affects the interests of the registered holders. Accordingly, Constellation or the combined company may amend the terms of the warrants in a manner adverse to a holder if holders of a majority of the then outstanding warrants approve of such amendment. Although Constellation’s or the combined company’s ability to amend the terms of the warrants with the consent of a majority of the then outstanding warrants is unlimited, examples of such amendments could be amendments to, among other things, increase the exercise price of the warrants, shorten the exercise period or decrease the number of ordinary shares purchasable upon exercise of the warrants.

The combined company may redeem your unexpired warrants prior to their exercise at a time that is disadvantageous to you, thereby making your warrants worthless.

The combined company will have the ability to redeem outstanding warrants at any time after they become exercisable and prior to their expiration, at a price of $0.01 per warrant, provided that the last reported sales price of the ordinary shares equals or exceeds $18.00 per share for any 20 trading days within a 30-trading day period ending on the third trading day prior to the date the combined company gives notice of redemption. If and when the warrants become redeemable by the combined company, the combined company may exercise its redemption right even if it is unable to register or qualify the underlying securities for sale under all applicable state securities laws. Redemption of the outstanding warrants could force you (i) to exercise your warrants and pay the exercise price therefor at a time when it may be disadvantageous for you to do so, (ii) to sell your warrants at the then-current market price when you might otherwise wish to hold your warrants or (iii) to accept the nominal redemption price which, at the time the outstanding warrants are called for redemption, is likely to be substantially less than the market value of your warrants. None of the private warrants will be redeemable by the combined company so long as they are held by their initial purchasers or their permitted transferees.

Constellation may amend the terms of the rights in a manner that may be adverse to holders with the approval by the holders of a majority of the then outstanding rights.

The rights are subject to the rights agreement, dated June 19, 2017, between Constellation and Continental Stock Transfer & Trust Company, as rights agent. The rights agreement provides that the terms of the rights may be amended without the consent of any holder to cure any ambiguity or correct any defective provision. The rights agreement requires the approval by the holders of a majority of the then outstanding rights (including the private rights) in order to make any change that adversely affects the interests of the registered holders.

Constellation believes it has been a passive foreign investment company, or PFIC, since its inception, which could result in adverse U.S. federal income tax consequences to U.S. taxpayers.

If Constellation is a PFIC for any taxable year (or portion thereof) that is included in the holding period of a U.S. taxpayer who holds Constellation’s ordinary shares, warrants or rights, the U.S. taxpayer may be subject to increased U.S. federal income tax liability and may be subject to additional reporting requirements. Because of the composition of Constellation’s assets and income, Constellation believes that it has been considered a PFIC since its inception and will be until it becomes a Delaware corporation pursuant to the Domestication (discussed further in the section entitled “ Proposal No.  2 – The Domestication Proposal – Material U.S. Federal Income Tax Consequences of the Domestication – PFIC Considerations ”). While there is a start-up exception from the

 

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PFIC rules, Constellation believes that it does not qualify for such exception. In addition, Constellation may not provide timely financial information that would be required for U.S. taxpayers to make a potentially favorable qualified electing fund, or QEF, election, and such election would be unavailable with respect to Constellation’s rights and warrants.

We urge U.S. taxpayers to consult their own tax advisors regarding the application of the PFIC rules.

An investor may be subject to adverse U.S. federal income tax consequences in the event the Internal Revenue Service, or the IRS, was to disagree with the U.S. federal income tax consequences described herein.

We have not sought a ruling from the IRS as to any U.S. federal income tax consequences described herein. The IRS may disagree with the descriptions of U.S. federal income tax consequences contained herein, and its determination may be upheld by a court. Any such determination could subject an investor or Constellation to adverse U.S. federal income tax consequences that would be different than those described herein. Accordingly, each prospective investor is urged to consult a tax advisor with respect to the specific tax consequences of the acquisition, ownership and disposition of Constellation’s ordinary shares, rights and warrants, including the applicability and effect of state, local or non-U.S. tax laws, as well as U.S. federal tax laws.

Constellation’s Corporate Effective Tax Rate may increase as a result of becoming a U.S. domiciled corporation.

In connection with the closing of the business combination, Constellation anticipates that it will change its jurisdiction of incorporation from the British Virgin Islands to Delaware, which change is referred to as the Domestication. As a result of the Domestication, Constellation will become subject to U.S. tax on Constellation’s income and capital gains. As a result, Constellation’s corporate effective tax rate may increase significantly, which could materially impact Constellation’s financial results, including its earnings and cash flow, for periods after the Domestication. Constellation’s current corporate effective tax rate fluctuates significantly from period to period, and is based upon the application of currently applicable income tax laws, regulations and treaties, as well as current judicial and administrative interpretations of these income tax laws, regulations and treaties, in various jurisdictions, in addition to the jurisdiction where Constellation’s parent is organized and domiciled.

The highest statutory corporate tax rate for U.S. federal income tax purposes is 21%. Constellation’s effective tax rate for purposes of financial reporting may, however, vary significantly from the statutory rates under which Constellation operates (including the U.S. statutory rate that would apply after the Domestication) because of, among other things, timing differences in the recognition of income and expense for U.S. GAAP and tax purposes, and differences in how each jurisdiction in which Constellation operates treats the same item of income or expense. Constellation is unable to predict the impact of the Domestication on its effective tax rate going forward for future years. In addition, the tax laws of the United States and other jurisdictions could change in the future, and those changes could cause a material increase in Constellation’s effective tax rate at a later date as well.

If the business combination results in an ownership change under Section 382 of the Code for DermTech, pre-merger U.S. net operating loss carryforwards and certain other tax attributes will be subject to limitations.

At December 31, 2018 and 2017, DermTech had federal tax net operating loss carryforwards of approximately $59,404,000 and $51,264,000, respectively, as well as state tax net operating loss carryforwards at December 31, 2018 and 2017 of approximately $45,647,000 and $38,738,000, respectively. The federal tax loss carryforwards began to expire in 2019, while the state tax loss carryforwards begin to expire in 2028. In general, under Section 382 of the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change NOLs to offset future taxable income. DermTech has not conducted a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since inception due to the significant complexity and cost associated with such a study. If DermTech undergoes an

 

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ownership change in connection with the business combination, the combined company’s ability to utilize NOLs could be further limited by Section 382 of the Code. Future changes in the combined company’s stock ownership, some of which are outside of the combined company’s control, could result in an ownership change under Section 382 of the Code. Furthermore, the combined company’s ability to utilize NOLs of companies that it may acquire in the future may be subject to limitations. For these reasons, the combined company may not be able to utilize a material portion of the NOLs, even if it were to achieve profitability.

The TCJA was enacted on December 22, 2017 and significantly reforms the Code. The TCJA, among other things, includes changes to U.S. federal tax rates and the rules governing net operating loss carryforwards. For NOLs arising in tax years beginning after December 31, 2017, the TCJA limits a taxpayer’s ability to utilize NOL carryforwards to 80% of annual taxable income. In addition, NOLs arising in tax years ending after December 31, 2017 can be carried forward indefinitely, but carryback is generally prohibited. NOLs generated in tax years beginning before January 1, 2018, will not be subject to the taxable income limitation, and NOLs generated in tax years ended before January 1, 2018 will continue to have a two-year carryback and twenty-year carryforward period. Deferred tax assets for NOLs will need to be measured at the applicable tax rate in effect when the NOL is expected to be utilized. The changes in the carryforward/carryback periods as well as the new limitation on use of NOLs may significantly impact the combined company’s valuation allowance assessments for NOLs generated after December 31, 2017.

The recently passed comprehensive tax reform bill could adversely affect the combined company’s business and financial condition.

In December 2017, the TCJA significantly revised the Code. The newly enacted federal income tax law, among other things, contains significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of annual taxable income and elimination of net operating loss carrybacks, one-time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, reduction or elimination of U.S. tax on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. Notwithstanding the reduction in the corporate income tax rate, the overall impact of the new federal tax law is uncertain and the combined company’s business and financial condition could be adversely affected. In addition, it is uncertain if and to what extent various states will conform to the newly enacted federal tax law. The impact of this tax reform on holders of common stock of the combined company is also uncertain and could be adverse. Stockholders of the combined company should consult with their legal and tax advisors with respect to this legislation and its potential tax consequences under their particular circumstances.

Currently, Constellation is governed by British Virgin Islands law but upon effectiveness of the Domestication, Constellation will be governed by Delaware law, which has anti-takeover implications.

Upon effectiveness of the Domestication, Constellation’s organizational documents will change and it and its organizational documents will be governed by Delaware law rather than British Virgin Islands law. The application of Delaware law to Constellation as a result of the Domestication may have the effect of deterring hostile takeover attempts or a change in control. Section 203 of the Delaware General Corporation Law, or the DGCL, restricts certain “business combinations” with “interested stockholders” for three years following the date that a person becomes an interested stockholder unless: (1) the “business combination” or the transaction which caused the person or entity to become an interested stockholder is approved by the Board of Directors prior to such business combination or transactions; (2) upon the completion of the transaction in which the person or entity becomes an “interested stockholder” such interested stockholder holds at least 85% of the voting stock of the combined company not including (x) shares held by officers and directors and (y) shares held by employee benefit plans under certain circumstances; or (3) at or after the person or entity becomes an “interested stockholder,” the “business combination” is approved by the Board of Directors and holders of at least 66 2/3%

 

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of the outstanding voting stock, excluding shares held by such interested stockholder. A Delaware corporation may elect not to be governed by Section 203. We do not anticipate making such an election.

Constellation’s board of directors may, to the extent permitted by applicable law, choose to waive any conditions to consummation of the business combination and proceed to consummate the business combination.

The Merger Agreement contains conditions precedent to the obligations of the parties to consummate the business combination. The Merger Agreement also provides that these conditions precedent may to the extent permitted by applicable law, be waived, in whole or in part, and the business combination consummated notwithstanding that a condition precedent has not been fulfilled or satisfied and notwithstanding that the waiver of the condition may directly or indirectly impact the financial condition of the combined company. The determination to waive the satisfaction of certain conditions will be made by Constellation’s board of directors. No additional vote of the shareholders will be required in connection with the waiver of a condition precedent.

The exercise of discretion by Constellation’s directors and officers in agreeing to changes to the terms of or waivers of closing conditions in the Merger Agreement may result in a conflict of interest when determining whether such changes to the terms of the Merger Agreement or waivers of conditions are appropriate and in the best interests of Constellation’s securityholders.

In the period leading up to the closing of the business combination, other events may occur that, pursuant to the Merger Agreement, would require Constellation to agree to amend the Merger Agreement, to consent to certain actions or to waive rights that Constellation is entitled to under the Merger Agreement. Such events could arise because of changes in the course of DermTech’s business, a request by the DermTech to undertake actions that would otherwise be prohibited by the terms of the Merger Agreement or the occurrence of other events that would have a material adverse effect on DermTech’s business and would entitle Constellation to terminate the Merger Agreement. In any of such circumstances, it would be in the discretion of Constellation, acting through its board of directors, to grant its consent or waive its rights. The existence of the financial and personal interests of the directors described elsewhere in this proxy statement/prospectus/information statement may result in a conflict of interest on the part of one or more of the directors between what he may believe is best for Constellation and its securityholders and what he may believe is best for himself or his affiliates in determining whether or not to take the requested action. As of the date of this proxy statement/prospectus/information statement, Constellation does not believe there will be any changes or waivers that Constellation’s directors and officers would be likely to make after shareholder approval of the Business Combination Proposal has been obtained. While certain changes may be made without further shareholder approval, if there is a change to the terms of the business combination that would have a material impact on the shareholders, Constellation will be required to circulate a new or amended proxy statement/prospectus/information statement or supplement thereto and resolicit the vote of its shareholders with respect to the Business Combination Proposal.

There may be sales of a substantial amount of the combined company’s common stock after the business combination by Constellation’s and DermTech’s current shareholders, and these sales could cause the price of Constellation’s securities to fall.

After the business combination and assuming consummation of the PIPE, there will be 26,295,225 shares of the combined company’s common stock outstanding (subject to certain assumptions, including: (i) all of Constellation’s issued and outstanding rights are converted into shares of common stock of the combined company upon consummation of the business combination; (ii) 6,153,847 shares of Constellation common stock are sold in the PIPE; (iii) none of Constellation’s public shareholders exercise their redemption rights; (iv) none of Constellation’s warrants are exercised to purchase shares of common stock of the combined company; and (v) 16,000,000 shares of common stock of the combined company are issued to current DermTech stockholders upon the completion of the business combination. If the actual facts are different than these assumptions, the number of shares of the combined company’s common stock issued and outstanding will be different. Of Constellation’s

 

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issued and outstanding ordinary shares that were issued prior to the business combination, all will be freely transferable, except for any ordinary shares held by the combined company’s “affiliates,” as that term is defined in Rule 144 under the Securities Act. Following completion of the business combination, Constellation expects that approximately 66% of the outstanding common stock of the combined company will be held by entities affiliated with the combined company and its executive officers and directors.

Future sales of the combined company’s common stock may cause the market price of Constellation’s securities to drop significantly, even if Constellation’s business is doing well.

After the business combination and pursuant to the Registration Rights Agreement, certain former DermTech stockholders will be entitled to demand that Constellation registers the resale of their securities subject to certain minimum requirements. These stockholders will also have certain “piggyback” registration rights with respect to registration statements filed subsequent to the business combination.

Upon effectiveness of any registration statement the combined company files pursuant to the Registration Rights Agreement, and upon the expiration of the lockup period applicable to the parties to the Registration Rights Agreement, these parties may sell large amounts of the combined company’s common stock in the open market or in privately negotiated transactions, which could have the effect of increasing the volatility in the share price of the combined company’s common stock or putting significant downward pressure on the price of the combined company’s common stock.

Sales of substantial amounts of the combined company’s common stock in the public market after the business combination, or the perception that such sales will occur, could adversely affect the market price of the combined company’s common stock and make it difficult for the combined company to raise funds through securities offerings in the future.

After the Closing, Constellation’s rights will convert into shares of common stock of the combined company and warrants will become exercisable for shares of the combined company, which would increase the number of shares eligible for future resale in the public market and result in dilution to Constellation’s shareholders.

If the business combination is completed, Constellation expects that its outstanding rights will convert into an aggregate of 1,493,625 shares of common stock of the combined company and outstanding warrants to purchase an aggregate of 7,468,125 shares of common stock of the combined company will become exercisable in accordance with the terms of the rights agreement and warrant agreement governing those securities. Holders of Constellation’s rights will need to affirmatively convert their rights after the consummation of the business combination. The warrants will become exercisable 30 days after the completion of the business combination, and will expire at 5:00 p.m., New York time, five years after the completion of the business combination or earlier upon redemption or liquidation. The exercise price of these warrants will be $11.50 per share, or approximately $85,883,438 in the aggregate for all shares underlying these warrants, assuming none of the warrants are exercised through “cashless” exercise. To the extent such warrants are exercised, additional shares of Constellation’s ordinary shares will be issued, which will result in dilution to the shareholders of the combined company and increase the number of shares of common stock eligible for resale in the public market. Sales of substantial numbers of such shares in the public market or the fact that such warrants may be exercised could adversely affect the market price of Constellation’s shares of common stock.

Because Constellation has no current plans to pay cash dividends on its ordinary shares for the foreseeable future, you may not receive any return on investment unless you sell your ordinary shares for a price greater than that which you paid for it.

Constellation may retain future earnings, if any, for future operations, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends as a public company in the future will be made at the discretion of Constellation’s board of directors and will depend

 

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on, among other things, Constellation’s results of operations, financial condition, cash requirements, contractual restrictions and other factors that Constellation’s board of directors may deem relevant. In addition, Constellation’s ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness it or its subsidiaries incur. As a result, you may not receive any return on an investment in Constellation’s ordinary shares unless you sell Constellation’s ordinary shares for a price greater than that which you paid for it. See the section entitled “ Market Price and Dividend Information – Dividends – Dividend Policy of Constellation .”

If, following the business combination, securities or industry analysts do not publish or cease publishing research or reports about the combined company, its business, or its market, or if they change their recommendations regarding the combined company’s securities adversely, the price and trading volume of the combined company’s securities could decline.

The trading market for the combined company’s securities will be influenced by the research and reports that industry or securities analysts may publish about the combined company, its business, market or competitors. Securities and industry analysts do not currently, and may never, publish research on the combined company. If no securities or industry analysts commence coverage of the combined company, the combined company’s share price and trading volume would likely be negatively impacted. If any of the analysts who may cover the combined company change their recommendation regarding the combined company’s shares of common stock adversely, or provide more favorable relative recommendations about the combined company’s competitors, the price of the combined company’s shares of common stock would likely decline. If any analyst who may cover the combined company were to cease coverage of the combined company or fail to regularly publish reports on it, the combined company could lose visibility in the financial markets, which in turn could cause its share price or trading volume to decline.

If Constellation fails to consummate the PIPE, it may not have enough funds to complete the business combination.

As a condition to Closing, the Merger Agreement provides that Constellation must have $15,000,000 available at the Closing. Because the amount in Constellation’s Trust Account is less than $15,000,000, Constellation requires the funds from the PIPE in order to consummate the business combination. While Constellation has entered into Subscription Agreements to raise an aggregate of approximately $20,000,000 immediately prior to the Closing, there can be no assurance that the counterparties to the Subscription Agreements will perform their obligations thereunder. If Constellation fails to consummate the PIPE, it is unlikely that Constellation will have sufficient funds to meet the condition to Closing in the Merger Agreement.

Constellation’s Proposed Amended and Restated Charter, to be in effect upon the completion of the business combination, will designate the Court of Chancery of the State of Delaware, or the Chancery Court, or the federal district court for the District of Delaware, or the District Court of Delaware, as the exclusive forum for certain types of actions and proceedings that may be initiated by the combined company’s stockholders, which could limit the combined company’s stockholders’ ability to obtain a favorable judicial forum for disputes with the combined company or its directors, officers or employees.

The combined company’s Proposed Amended and Restated Charter, to be in effect upon the completion of the business combination, will require, unless the combined company otherwise consents, that the Chancery Court will be the sole and exclusive forum for the following types of actions or proceedings under Delaware statutory or common law: (i) any derivative action or proceeding brought on the combined company’s behalf, (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any of the combined company’s current or former directors, officers and employees to the combined company or its stockholders, (iii) any action or proceeding asserting a claim against the combined company or any of its current or former directors, officers or employees, arising out of or pursuant to any provision of the DGCL, the combined company’s Proposed Amended and Restated Charter to be in effect following the completion of the business

 

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combination or the combined company’s Proposed Amended and Restated Bylaws to be in effect following the completion of the business combination, (iv) any action or proceeding to interpret, apply, enforce or determine the validity of the combined company’s Proposed Amended and Restated Bylaws to be in effect following the completion of the business combination, (v) any action or proceeding as to which the DGCL confers jurisdiction to the Chancery Court, or (vi) any action or proceeding asserting a claim against the combined company, or its directors, officers or employees, relating to certain internal affairs matters. If the Chancery Court does not have jurisdiction for these actions or proceedings, then the actions or proceedings must be brought in a state court located in the State of Delaware. If these state courts also do not have jurisdiction, these actions or proceedings must be brought in the District Court of Delaware. These limitations in the combined company’s Proposed Amended and Restated Charter to be in effect upon the completion of this offering will not apply to actions brought to enforce a duty or liability created by the Securities Act, the Exchange Act or to any claim for which the federal courts have exclusive jurisdiction. In addition, any person purchasing or otherwise acquiring any interest in any shares of the combined company’s capital stock shall be deemed to have notice of and to have consented to this provision of the combined company’s Proposed Amended and Restated Charter. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with the combined company or its directors, officers or employees, which may discourage such lawsuits against the combined company and its directors, officers and employees even though an action, if successful, might benefit the combined company’s stockholders. Stockholders who do bring a claim in the Chancery Court or the District Court of Delaware could face additional litigation costs in pursuing any such claim, particularly if they do not reside in or near the jurisdiction. The Chancery Court or the District Court of Delaware may also reach different judgments or results than would other courts, including courts where a stockholder considering an action may be located or would otherwise choose to bring the action, and such judgments or results may be more favorable to the combined company than to the combined company’s stockholders. Alternatively, if a court were to find these provisions of the combined company’s Proposed Amended and Restated Charter to be in effect upon the completion of this offering inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, the combined company may incur additional costs, which could have a material adverse effect on the combined company’s business, financial condition or results of operations.

 

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THE SPECIAL MEETING OF CONSTELLATION SHAREHOLDERS

General

Constellation is furnishing this proxy statement/prospectus/information statement to its shareholders as part of the solicitation of proxies by Constellation’s board of directors for use at the special meeting of shareholders to be held on                , 2019, and at any adjournment or postponement thereof. This proxy statement/prospectus/information statement is first being furnished to Constellation’s shareholders on or about                , 2019. This proxy statement/prospectus/information statement provides you with information you need to know to be able to vote or instruct your vote to be cast at the special meeting.

Date, Time and Place of Special Meeting

The special meeting will be held at 10:00 a.m. Eastern time, on                , 2019, at the offices of Greenberg Traurig, LLP, 200 Park Avenue, New York, NY 10166, or such other date, time and place to which such meeting may be adjourned or postponed, to consider and vote upon the proposals.

Purpose of the Special Meeting

At the special meeting of shareholders, Constellation will ask the Constellation shareholders to vote in favor of the following proposals:

 

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The Business Combination Proposal – a proposal to approve the adoption of the Merger Agreement and the business combination contemplated under the Merger Agreement;

 

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The Domestication Proposal – a proposal to (a) approve the Domestication of Constellation; (b) adopt, upon the Domestication taking effect, the Interim Charter in place of Constellation’s Current Charter, which will remove or amend those provisions of our Current Charter that terminate or otherwise cease to be applicable as a result of the Domestication and provide for a majority of the stockholders to act by written consent; (c) file a notice of continuation out of the British Virgin Islands with the British Virgin Islands Registrar of Corporate Affairs under Section 184 of the BVI Companies Act; and (d) file the Interim Charter with the Secretary of State of Delaware;

 

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The Charter Amendment Proposal – to approve and adopt, subject to and conditional on the Domestication and the closing of the business combination (but with immediate effect upon the closing of the business combination), separate proposals to adopt the Proposed Amended and Restated Bylaws and amendments to Constellation’s Interim Charter, as set out in the draft Proposed Amended and Restated Charter to (a) change the name of Constellation to DermTech, Inc., (b) remove or amend those provisions of our Interim Charter which terminate or otherwise cease to be applicable following the closing of the business combination, and (c) add new provisions to our Interim Charter which will be applicable following the closing of the business combination;

 

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The Incentive Plan Proposal – to consider and vote upon a proposal to approve and assume the DermTech Plan and all outstanding DermTech equity awards granted thereunder;

 

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The Nasdaq Proposal – a proposal to consider and vote upon a proposal to approve, for purposes of complying with applicable Nasdaq Listing Rules, the issuance of more than 20% of the current total issued and outstanding ordinary shares of Constellation, which Nasdaq may deem to be a change of control pursuant to the Business Combination; and

 

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The Adjournment Proposal – a proposal to authorize the adjournment of the special meeting to a later date or dates, if necessary, to permit further solicitation and vote of proxies if, based on the tabulated vote at the time of the special meeting, there are not sufficient votes to approve the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal or the Nasdaq Proposal, or public shareholders have elected to redeem an amount of public shares such that the minimum available cash condition to the obligation to closing of the business combination would not be satisfied.

 

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Recommendation of Constellation’s Board of Directors

Constellation’s board of directors believes that each of the Business Combination Proposal, the Domestication Proposal, the Charter Amendment Proposal, the Incentive Plan Proposal, the Nasdaq Proposal and the Adjournment Proposal to be presented at the special meeting is in the best interests of Constellation and its shareholders and unanimously recommends that its shareholders vote “FOR” each of the proposals.

When you consider the recommendation of Constellation’s board of directors in favor of approval of the Business Combination Proposal, you should keep in mind that certain of Constellation’s directors and officers have interests in the business combination that are different from, or in addition to, your interests as a shareholder. These interests include, among other things:

 

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the beneficial ownership of Constellation’s sponsor and directors of an aggregate of 3,882,500 ordinary shares, which shares would become worthless if Constellation does not complete a business combination within the applicable time period, as Constellation’s initial shareholders have waived any right to redemption with respect to these ordinary shares. Such shares have an aggregate market value of approximately $40,145,050 based on the closing price of the ordinary shares of $10.34 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders;

 

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the beneficial ownership of Constellation’s sponsor and directors of warrants to purchase 212,500 ordinary shares, which warrants would expire and become worthless if Constellation does not complete a business combination within the applicable time period. Such warrants have an aggregate market value of approximately $10,625 based on the closing price of Constellation’s warrants of $0.05 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders;

 

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the beneficial ownership of Constellation’s sponsor and directors of rights to receive 42,500 ordinary shares, which rights will become worthless if Constellation does not complete a business combination within the applicable time period. Such rights have an aggregate market value of approximately $8,075 based on the closing price of Constellation’s rights of $0.19 on Nasdaq on June 12, 2019, the record date for the special meeting of shareholders; and

 

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as of                , 2019, Constellation’s initial shareholders have advanced approximately $                to Constellation for operating expenses. Such advances will be repaid only if Constellation completes a business combination.

Voting Power; Record Date

You will be entitled to vote or direct votes to be cast at the special meeting if you owned Constellation’s ordinary shares at the close of business on                , 2019, which is the record date for the special meeting. You are entitled to one vote for each ordinary share that you owned as of the close of business on the record date. If your shares are held in “street name” or are in a margin or similar account, you should contact your broker, bank or other nominee to ensure that votes related to the shares you beneficially own are properly counted. On the record date, there were 5,342,532 ordinary shares outstanding, of which 1,187,532 are public shares, 3,593,750 are founder shares held by Constellation’s initial shareholders and 561,250 are private shares held by Constellation’s initial shareholders.

Vote of Initial Shareholders

In connection with Constellation’s initial public offering, Constellation entered into an agreement with its initial shareholders, directors and officers pursuant to which they each agreed to vote the Founder Shares and any other shares acquired during and after Constellation’s initial public offering in favor of the Business Combination Proposal. This agreement applies to Constellation’s sponsor as it relates to the Founder Shares and private shares and the requirement to vote its Founder Shares and private shares in favor of the Business Combination Proposal.

Constellation’s initial shareholders have also agreed to waive their redemption rights with respect to their Founder Shares and private shares and to waive their redemption rights with respect to any public shares that

 

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they may acquire in connection with the completion of the business combination. The Founder Shares and private shares have no redemption rights upon Constellation’s liquidation and will be worthless if no business combination is effected by Constellation prior to September 23, 2019, unless a further extension is approved by Constellation’s shareholders. However, Constellation’s initial shareholders are entitled to redemption rights upon Constellation’s liquidation with respect to any public shares they may own.

Who Can Answer Your Questions About Voting

If you have any questions about how to vote or direct a vote in respect of your ordinary shares, you may contact us at:

Constellation Alpha Capital Corp.

Attention: Rajiv Shukla

Emerald View, Suite 400

2054 Vista Parkway

West Palm Beach, FL 33411

Tel: (561) 404-9034

Email: info@constellationalpha.com

Quorum and Required Vote for Proposals for the Special Meeting of Shareholders

A quorum of Constellation’s shareholders is necessary to hold a valid meeting. A quorum will be present at the special meeting if at least 50% of Constellation’s ordinary shares outstanding and entitled to vote at the special meeting are represented in person or by proxy. Abstentions will count as present for the purposes of establishing a quorum.

The approval of each of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal and Adjournment Proposal requires the affirmative vote of the holders of a majority of the ordinary shares that are voted on each such proposal at the special meeting. Accordingly, a shareholder’s failure to vote by proxy or to vote in person at the special meeting, an abstention from voting, or a broker non-vote will have no effect on the outcome of a vote on any of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal or Adjournment Proposal.

Broker Non-Votes and Abstentions

Under the rules of various national and regional securities exchanges, your broker, bank or nominee cannot vote your shares with respect to non-discretionary matters unless you provide instructions on how to vote in accordance with the information and procedures provided to you by your broker, bank or nominee. Constellation believes the proposals presented to its shareholders will be considered non-discretionary and therefore your broker, bank or nominee cannot vote your shares without your instruction. If you do not provide instructions with your proxy, your bank, broker or other nominee may deliver a proxy card expressly indicating that it is NOT voting your shares; this indication that a bank, broker or nominee is not voting your shares is referred to as a “broker non-vote.”

With respect to the special meeting, abstentions are considered present for the purposes of establishing a quorum but will have no effect on the outcome of a vote on any of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal or Adjournment Proposal. Broker non-votes will not be counted for the purposes of establishing a quorum and will have no effect on the outcome of a vote on any of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal or Adjournment Proposal.

 

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Voting Your Shares

Each ordinary share that you own in your name entitles you to one vote on each of the proposals for the special meeting of shareholders. Your one or more proxy cards show the number of ordinary shares that you own.

If you are a holder of record, there are two ways to vote your shares:

 

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You can vote by completing, signing and returning the enclosed proxy card in the postage-paid envelope provided. If you hold your shares in “street name” through a bank, broker or other nominee, you will need to follow the instructions provided to you by your bank, broker or other nominee to ensure that your shares are represented and voted at the applicable special meeting(s). If you vote by proxy card, your “proxy,” whose name is listed on the proxy card, will vote your shares as you instruct on the proxy card. If you sign and return the proxy card but do not give instructions on how to vote your shares, your ordinary shares will be voted, as recommended by Constellation’s board of directors. With respect to proposals for the special meeting, that means: “FOR” each of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal and Adjournment Proposal.

 

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You can attend the special meeting and vote in person. You will be given a ballot when you arrive. However, if your ordinary shares are held in the name of your broker, bank or other nominee, you must get a proxy from the broker, bank or other nominee. That is the only way we can be sure that the broker, bank or nominee has not already voted your ordinary shares.

Revoking Your Proxy

If you have submitted a proxy to vote your ordinary shares and wish to change your vote, you may do so by delivering a later-dated, signed proxy card to us, prior to the date of the special meeting or by voting in person at the special meeting. Attendance at the special meeting alone will not change your vote. You also may revoke your proxy by sending a notice of revocation to us at: Constellation Alpha Capital Corp., Attention: Rajiv Shukla, Emerald View, Suite 400, 2054 Vista Parkway, West Palm Beach, FL 33411.

No Additional Matters May Be Presented at the Special Meeting

The special meeting has been called only to consider the approval of the Business Combination Proposal, Domestication Proposal, Charter Amendment Proposal, Incentive Plan Proposal, Nasdaq Proposal and Adjournment Proposal. Under Constellation’s memorandum and articles of association, other than procedural matters incident to the conduct of the special meeting, no other matters may be considered at the special meeting if they are not included in this proxy statement/prospectus/information statement, which serves as the notice of the special meeting.

Redemption Rights

Pursuant to Constellation’s memorandum and articles of association, holders of public shares may demand that such shares be redeemed in exchange for a pro rata share of the aggregate amount on deposit in the Trust Account, less taxes payable, calculated as of two business days prior to the consummation of the business combination. If demand is properly made and the business combination is consummated, these shares, immediately prior to the business combination, will cease to be outstanding and will represent only the right to receive a pro rata share of the aggregate amount on deposit in the Trust Account as of two business days prior to the consummation of the business combination, less taxes payable, upon the consummation of the business combination. For illustrative purposes, based on funds in the Trust Account of approximately $12.4 million on May 28, 2019, the estimated per share redemption price would have been approximately $10.45.

Redemption rights are not available to holders of rights or warrants in connection with the business combination.

 

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In order to exercise your redemption rights, you must, prior to 4:30 p.m., Eastern time, on                , 2019 (two business days before the special meeting), both:

 

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Submit a request in writing that Constellation redeem your public shares for cash to Continental Stock Transfer & Trust Company, Constellation’s transfer agent, at the following address:

Continental Stock Transfer & Trust Company

One State Street Plaza, 30th Floor

New York, New York 10004-1561

Attn: Mark Zimkind

E-mail: mzimkind@continentalstock.com

 

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Deliver your public shares either physically or electronically through DTC to Constellation’s transfer agent. Shareholders seeking to exercise their redemption rights and opting to deliver physical certificates should allot sufficient time to obtain physical certificates from the transfer agent. It is Constellation’s understanding that shareholders should generally allot at least one week to obtain physical certificates from the transfer agent. However, Constellation does not have any control over this process and it may take longer than one week. Shareholders who hold their shares in street name will have to coordinate with their bank, broker or other nominee to have the shares certificated or delivered electronically. If you do not submit a written request and deliver your public shares as described above, your shares will not be redeemed.

Any demand for redemption, once made, may be withdrawn at any time until the deadline for exercising redemption requests and thereafter, with Constellation’s consent, until the vote is taken with respect to the business combination. If you delivered your shares for redemption to Constellation’s transfer agent and decide within the required timeframe not to exercise your redemption rights, you may request that Constellation’s transfer agent return the shares (physically or electronically). You may make such request by contacting Constellation’s transfer agent at the phone number or address listed above.

Each redemption of public shares by Constellation’s public shareholders will decrease the amount in the Trust Account. In no event, however, will Constellation redeem public shares in an amount that would cause its net tangible assets to be less than $5,000,001.

Prior to exercising redemption rights, shareholders should verify the market price of their ordinary shares as they may receive higher proceeds from the sale of their ordinary shares in the public market than from exercising their redemption rights if the market price per share is higher than the redemption price. Constellation cannot assure you that you will be able to sell your ordinary shares in the open market, even if the market price per share is higher than the redemption price stated above, as there may not be sufficient liquidity in the ordinary shares when you wish to sell your shares.

If you exercise your redemption rights, your ordinary shares will cease to be outstanding immediately prior to the business combination and will only represent the right to receive a pro rata share of the aggregate amount on deposit in the Trust Account. You will no longer own those shares. You will be entitled to receive cash for these shares only if you properly demand redemption.

If the Business Combination Proposal is not approved and Constellation does not consummate an initial business combination by September 23, 2019, unless a further extension is approved by Constellation’s shareholders, it will be required to dissolve and liquidate and the rights and warrants will expire worthless.

Appraisal Rights

Appraisal rights are not available to holders of shares of Constellation’s units, ordinary shares, rights or warrants in connection with the business combination.

 

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Material U.S. Federal Income Tax Consequences of the Exercise of Redemption Rights

The following is a discussion of the material U.S. federal income tax consequences to U.S. Holders (as defined below) of Constellation ordinary shares who exercise their redemptions rights to receive cash from the trust account (with each such exercise called a “Redemption”). This summary is based upon the Code, the regulations promulgated by the U.S. Treasury Department, current administrative interpretations and practices of the IRS, and judicial decisions, all as currently in effect as of the date hereof and all of which are subject to differing interpretations or to change, possibly with retroactive effect. No assurance can be given that the IRS would not assert, or that a court would not sustain, a position contrary to any of the tax considerations described below. No advance ruling has been or will be sought from the IRS regarding any matter discussed in this summary. This summary does not discuss the impact that U.S. state and local taxes and taxes imposed by non-U.S. jurisdictions could have on the matters discussed in this summary. This summary does not purport to discuss all aspects of U.S. federal income taxation that may be important to a particular shareholder in light of its investment or tax circumstances or to shareholders subject to special tax rules, such as:

 

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certain U.S. expatriates;

 

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a dealer in securities or foreign currencies;

 

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traders in securities that elect mark-to-market treatment;

 

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pass-through entities such as partnerships, S corporations, disregarded entities for federal income tax purposes and limited liability companies (and investors therein);

 

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U.S. Holders (as defined below) whose functional currency is not the U.S. dollar;

 

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financial institutions or banks;

 

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a person that received Constellation ordinary shares as compensation for services;

 

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mutual funds;

 

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qualified plans, such as 401(k) plans, individual retirement accounts, etc.;

 

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insurance companies;

 

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broker-dealers;

 

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regulated investment companies (or RICs);

 

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real estate investment trusts (or REITs);

 

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persons holding Constellation ordinary shares stock as part of a “ straddle, ” “ wash sale, ” “ hedge, ” “ conversion transaction, ” “ synthetic security ,” or other integrated investment;

 

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persons subject to the alternative minimum tax provisions of the Code;

 

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tax-exempt organizations;

 

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persons that actually or constructively own five percent or more of Constellation ordinary shares;

 

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redeeming non-U.S. Holders (as defined below);

 

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a controlled foreign corporation; and/or

 

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a passive foreign investment company.

If any partnership (including for this purpose any entity treated as a partnership for U.S. federal income tax purposes) holds Constellation ordinary shares, the tax treatment of a partner generally will depend on the status of the partner and the activities of the partner and the partnership. If you are a partner of a partnership holding Constellation ordinary shares, you should consult your tax advisor. This summary assumes that shareholders hold Constellation ordinary shares as capital assets within the meaning of Section 1221 of the Code, which generally means as property held for investment and not as a dealer or for sale to customers in the ordinary course of the shareholder’s trade or business.

 

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This summary does not address the tax consequences to Constellation stockholders under any state, local or foreign tax laws or the U.S. federal estate or gift, Medicare net investment income, or alternative minimum tax provisions of the Code. This summary does not address the U.S. federal income tax consequences of transactions effectuated prior or subsequent to, or concurrently with, a Redemption (whether or not any such transactions are undertaken in connection with a Redemption) including, without limitation, the exercise of an option to acquire Constellation ordinary shares or other rights to acquire Constellation ordinary shares.

WE URGE HOLDERS OF CONSTELLATION ORDINARY SHARES TO CONSULT THEIR TAX ADVISOR REGARDING THE U.S. FEDERAL, STATE, LOCAL, AND FOREIGN INCOME AND OTHER TAX CONSEQUENCES OF A REDEMPTION.

U.S. Federal Income Tax Consequences to U.S. Holders

This section is addressed to U.S. Holders of Constellation ordinary shares who exercise their redemption rights to receive cash from the trust account. For purposes of this discussion, a “ U.S. Holder ” is a beneficial owner that is, for U.S. federal income tax purposes:

 

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a citizen or resident of the United States;

 

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a corporation (including an entity treated as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States or any political subdivision thereof;

 

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an estate the income of which is subject to U.S. federal income taxation regardless of its source; or

 

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any trust if (1) a U.S. court is able to exercise primary supervision over the administration of such trust and one or more U.S. persons have the authority to control all substantial decisions of the trust or (2) it has a valid election in place to be treated as a U.S. person.

Redemption of Constellation Ordinary Shares

Subject to the PFIC rules discussed below (see sectioned entitled “ PFIC Considerations ”), U.S. Holders of Constellation ordinary shares who exercise their redemption rights to receive cash from the trust account in exchange for all of their Constellation ordinary shares generally will be required, subject to the following paragraphs, to treat the transaction as a sale of such shares and recognize gain or loss upon the Redemption in an amount equal to the difference, if any, between the amount of cash received and the tax basis of the Constellation ordinary shares redeemed. A U.S. Holder’s tax basis in such Constellation ordinary shares generally will equal the cost of such shares. A shareholder that purchased Constellation units would have been required to allocate the cost between the Constellation ordinary shares and the public warrants comprising the units based on their relative fair market values at the time of the purchase. Subject to the passive foreign investment company rules discussed below, a shareholder’s gain or loss on a Redemption should be treated as capital gain or loss if such shares were held as a capital asset on the date of the Redemption. The deductibility of capital losses is subject to limitations. U.S. Holders that acquired Constellation ordinary shares at different dates or at different prices should consult their tax advisors to determine how the above rules apply to them.

If a U.S. Holder does not exchange all of its Constellation ordinary shares in a Redemption, such Redemption will generally still be treated as a sale or exchange of Constellation ordinary shares , with the consequences described in the immediately preceding paragraph, if the Redemption: (i) is “not essentially equivalent to a dividend” with respect to such U.S. Holder under Section 302(b)(1) of the Code; (ii) is a “substantially disproportionate” redemption with respect to such U.S. Holder under Section 302(b)(2) of the Code; or (iii) results in a “complete redemption” of such U.S. Holder’s interest in our stock under Section 302(b)(3) of the Code. In determining whether any of the foregoing tests are satisfied, a U.S. Holder takes into account not only stock actually owned by the U.S. Holder, but also shares of Constellation ordinary shares that are constructively owned by such U.S. Holder. A U.S. Holder may constructively own, in addition to stock owned directly, stock owned by certain related individuals and entities in which the U.S. Holder has an interest or that have an interest

 

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in such U.S. Holder, as well as any stock the U.S. Holder has a right to acquire by exercise of an option, which generally would include stock that could be acquired pursuant to the exercise of the public warrants. In order to meet the substantially disproportionate test, the percentage of Constellation’s outstanding voting stock actually and constructively owned by the U.S. Holder immediately following a Redemption must, among other requirements, be less than 80 percent of the percentage of Constellation’s outstanding voting stock actually and constructively owned by the U.S. Holder immediately before the Redemption. There will be a complete termination of a U.S. Holder’s interest if either all the shares of Constellation actually and constructively owned by the U.S. Holder are redeemed or all the shares of Constellation actually owned by the U.S. Holder are redeemed and the U.S. Holder is eligible to waive, and effectively waives in accordance with specific rules, the attribution of shares owned by certain family members and the U.S. Holder does not constructively own any other shares of Constellation. A Redemption of the shares will not be essentially equivalent to a dividend if a U.S. Holder’s Redemption results in a “meaningful reduction” of the U.S. holder’s proportionate interest in Constellation. Whether a Redemption will result in a meaningful reduction in a U.S. holder’s proportionate interest in Constellation will depend on the particular facts and circumstances. However, the IRS has indicated in a published ruling that even a small reduction in the proportionate interest of a small minority shareholder in a publicly held corporation who exercises no control over corporate affairs may constitute such a “meaningful reduction.” A U.S. Holder should consult with its own tax advisors as to the tax consequences of a Redemption.

If a Redemption does not qualify as a sale or exchange of Constellation ordinary shares under Section 302 of the Code, then the U.S. Holder will be treated as receiving a corporate distribution. Subject to the passive foreign investment company rules discussed below, such distribution generally will constitute a dividend for U.S. federal income tax purposes to the extent paid from current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Distributions in excess of current and accumulated earnings and profits will constitute a return of capital that will be applied against and reduce (but not below zero) the U.S. Holder’s adjusted tax basis in such U.S. Holder’s Constellation ordinary shares. Any remaining excess will be treated as gain realized on the sale or other disposition of the shares. Special rules may apply to dividends received by U.S. Holders that are taxable corporations. After the application of the foregoing rules, any remaining tax basis of the U.S. Holder in the redeemed shares will be added to the U.S. Holder’s adjusted tax basis in its remaining stock, or, if it has none, to the U.S. Holder’s adjusted tax basis in its warrants or possibly in other shares constructively owned by it.

Each U.S. Holder should consult its own tax advisor regarding the tax treatment of a Redemption.

PFIC Considerations

In addition to the discussion above, a Redemption could be subject to the passive foreign investment company provisions of the Code if Constellation is or ever was a passive foreign investment company or PFIC.

A. Definition of a PFIC

In general, Constellation will be a PFIC with respect to a U.S. Holder if, for any taxable year in which such U.S. Holder held Constellation ordinary shares, (a) at least 75% or more of Constellation’s gross income for the taxable year was passive income or (b) at least 50% or more of the value, determined on the basis of a quarterly average, of Constellation’s assets is attributable to assets that produce or are held to produce passive income. Passive income generally includes dividends, interest, rents and royalties (other than certain rents and royalties that are derived in the active conduct of a trade or business), and gains from the disposition of passive assets.

B. PFIC Status of Constellation

Constellation believes that it has been considered a PFIC since its inception. The determination of whether a foreign corporation is a PFIC is primarily factual and there is little administrative or judicial authority on which to rely to make a determination.

 

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C. Effects of PFIC Rules on a Redemption

If the Constellation were classified as a PFIC at any time during such U.S. Holder’s holding period in such ordinary shares and the U.S. Holder had not made a QEF election under Section 1295 of the Code for the first taxable year in which the U.S. Holder owned Constellation ordinary shares or in which Constellation was a PFIC, whichever is later, Section 1291 of the Code generally requires taxable gain to U.S. Holders of Constellation ordinary shares in a Redemption to be taxed at the rate applicable to ordinary income and an interest charge would apply based on a complex set of computational rules designed to offset the tax deferral with respect to the undistributed earnings of Constellation. Under these rules:

 

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the U.S. Holder’s gain would be allocated ratably over the U.S. Holder’s holding period for such holder’s Constellation ordinary shares;

 

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the amount of gain allocated to the U.S. Holder’s taxable year in which the U.S. Holder recognized the gain, or to the period in the U.S. Holder’s holding period before the first day of the first taxable year in which Constellation was a PFIC, would be taxed as ordinary income;

 

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the amount of gain allocated to other taxable years (or portions thereof) of the U.S. Holder and included in such holder’s holding period would be taxed at the highest tax rate in effect for that year applicable to the U.S. Holder; and

 

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the interest charge generally applicable to underpayments of tax would be imposed in respect of the tax attributable to each such other taxable year of the U.S. Holder.

If a U.S. Holder is treated as receiving a corporate distribution in a Redemption instead of a sale of ordinary shares, any amounts distributed to a U.S. Holder generally would be treated in the same manner as gain subject to the PFIC rules.

The PFIC rules are complex and the implementation of certain aspects of the PFIC rules requires the issuance of Treasury regulations which in many instances have not been promulgated and which may be promulgated and which may have retroactive effect. There can be no assurance that any of these proposals will be enacted or promulgated, and if so, the form they will take or the effect that they may have on this discussion. Accordingly, and due to the complexity of the PFIC rules, U.S. Holders are strongly urged to consult their own tax advisors concerning the impact of these rules on a Redemption, including, without limitation, whether a QEF election, deemed sale election and/or mark to market election is available with respect to their Constellation ordinary shares and the consequences to them of any such election. In addition, Constellation may not provide timely financial information that would be required for U.S. taxpayers to make a potentially favorable QEF election.

Information Reporting Requirements and Backup Withholding

Under U.S. federal income tax and U.S. Treasury Regulations, certain categories of U.S. Holders must file information returns with respect to their investment in, or involvement in, a foreign corporation. U.S. Holders are urged to consult with their own tax advisors concerning such reporting requirements.

SHAREHOLDERS ARE STRONGLY URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX CONSEQUENCES OF A REDEMPTION IN THEIR PARTICULAR CIRCUMSTANCES.

Solicitation of Proxies

Constellation will pay the cost of soliciting proxies for the special meeting. Constellation will reimburse banks, brokers and other custodians, nominees and fiduciaries representing beneficial owners of ordinary shares for their expenses in forwarding soliciting materials to beneficial owners of ordinary shares and in obtaining voting instructions from those owners. Constellation’s directors, officers and employees may solicit proxies by telephone, by facsimile, by mail, on the Internet or in person. They will not be paid any additional amounts for soliciting proxies.

 

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Share Ownership

As of the record date, Constellation’s sponsor beneficially owns an aggregate of approximately 72.7% of Constellation’s outstanding ordinary shares. Constellation’s sponsor has agreed to vote all of its founder shares and any public shares acquired by it in favor of the Business Combination Proposal.

 

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THE BUSINESS COMBINATION

This section and the section entitled “The Merger Agreement” beginning on page 115 of this proxy statement/prospectus/information statement describe the material aspects of the business combination, including the Merger Agreement. While Constellation and DermTech believe that this description covers the material terms of the business combination and the Merger Agreement, it may not contain all of the information that is important to you. You should read carefully this entire proxy statement/prospectus/information statement for a more complete understanding of the business combination and the Merger Agreement, including the Merger Agreement itself which is attached as Annex A to this proxy statement/prospectus/information statement, and the other documents to which you are referred herein. See the section entitled “Where You Can Find More Information” beginning on page 255 of this proxy statement/prospectus/information statement.

Background of the Business Combination

Constellation was formed for the purpose of acquiring, engaging in a share exchange, share reconstruction and amalgamation with, purchasing all or substantially all of the assets of, entering into contractual arrangements with, or engaging in any other similar business combination with one or more businesses or entities. Constellation is not limited to any particular industry or sector.

Constellation received $143.75 million of the proceeds from its initial public offering, which was consummated on June 23, 2017. The proceeds of the initial public offering, including proceeds from the exercise of the underwriters’ over-allotment option, were placed in the trust account immediately following the initial public offering and, in accordance with Constellation’s memorandum and articles of association, will be released upon the consummation of the business combination.

Except for all interest income that may be released to Constellation to pay taxes and up to $50,000 to pay liquidation expenses, none of the funds held in the trust account will be released until the earlier of (x) the completion of Constellation’s initial business combination within the required time period, (y) the redemption of 100% of the public shares if Constellation has not completed an initial business combination by September 23, 2019 (as a result of the extension described below) or (z) the redemption of any public shares properly tendered in connection with a shareholder vote to amend Constellation’s memorandum and articles of association (A) to modify the substance or timing of its obligation to redeem 100% of the public shares if it does not complete an initial business combination within the required time period or (B) with respect to any other provision relating to shareholders’ rights or pre-business combination activity. In the event of Constellation’s liquidation for failure to complete a business combination within the allotted time, up to $50,000 of net interest may be released to Constellation if Constellation has no or insufficient working capital to fund the costs and expenses of its dissolution and liquidation. After the payment of approximately $3.4 million in expenses relating to the initial public offering, approximately $700,000 of the net proceeds of the initial public offering and private placement of the private units was retained by Constellation for working capital purposes. The funds in the trust account are invested in U.S. government treasury bills with a maturity of 180 days or less or money market funds meeting certain conditions under Rule 2a-7 under the Investment Company Act of 1940, as amended, which invest only in direct U.S. government treasury obligations.

On March 21, 2019, at a special meeting of Constellation’s shareholders, an amendment to Constellation’s memorandum and articles of association was approved to extend the date by which Constellation has to consummate a business combination for an additional six months, from March 23, 2019 to September 23, 2019. The purpose of the extension was to allow Constellation more time to complete a business combination transaction. Following redemptions of 13,187,468 of Constellation’s ordinary shares in connection with the extension, a total of approximately $12.3 million remained in Constellation’s trust account.

Prior to the consummation of the initial public offering, neither Constellation, nor anyone on its behalf, contacted any prospective target business or had any substantive discussions, formal or otherwise, with respect to a potential transaction with Constellation.

 

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Following the initial public offering, Constellation’s acquisition team, which included certain officers and directors of Constellation, commenced a comprehensive search for a target business. During the course of this search process, Constellation reviewed and considered more than 65 companies and engaged with several possible target businesses in detailed substantive discussions or negotiations with respect to potential transactions. Constellation entered into substantive discussions with a number of potential target companies, including discussions regarding the type and amount of consideration to be provided relative to a potential transaction and entered into a definitive business combination agreement with one target company, as described below. Constellation delivered non-binding letters of intent to nine companies. The decision not to pursue alternative acquisition targets was generally the result of Constellation’s determination that each business was not an attractive target due to a combination of business prospects, strategy, management teams, structure and valuation differences.

On August 2, 2018, Constellation entered into an agreement, or the Share Purchase Agreement, to purchase all of the issued and outstanding shares of capital stock of Medall Healthcare Private Limited, a company registered under the laws of India, or Medall. On December 3, 2018, the Share Purchase Agreement terminated automatically.

On December 5, 2018, Constellation executed a non-disclosure agreement with DermTech and received access to the DermTech dataroom for legal and financial due diligence. On December 6, 2018, Mr. Rajiv Shukla, Constellation’s chief executive officer, and Mr. Craig Pollak, Constellation’s chief financial officer, discussed transaction terms with Dr. John Dobak, DermTech’s president and chief executive officer, Mr. Steve Kemper, DermTech’s chief financial officer and their financial advisors. On December 10, 2018, Constellation and DermTech executed a non-binding term sheet with a 30-day exclusivity period.

On December 11, 2018, Mr. Shukla met with Dr. Dobak and Mr. Kemper to discuss process and timing for the potential transaction. On December 12, 2018, Mr. Shukla met with the board of directors of DermTech and subsequently met with members of DermTech’s management team to address questions regarding process, potential timing and key aspects of business strategy going forward.

On December 21, 2018, Mr. Shukla, Mr. Pollak, Dr. Dobak and Mr. Kemper along with their financial advisors conducted a telephonic discussion centered on diligence items, fund raising, and negotiation around key transaction terms.

During the period from December 10, 2018 and until May 2019, Constellation conducted legal and financial due diligence on DermTech. On January 5, 2019, Mr. Shukla conducted a status update call with Dr. Dobak and a representative of RTW Investments L.P., an investor in DermTech. On January 7, 2019, Mr. Shukla conducted a call with Dr. Dobak to discuss diligence items. On January 8, 2019, DermTech extended exclusivity for the non-binding term sheet for an additional 30 days. On January 17, 2019, the parties and their financial advisors conducted a status update call. On January 25, 2019, DermTech and Constellation conducted an update call regarding the proposed PIPE financing. On February 5, 2019, DermTech held a meeting of its board of directors to discuss matters related to the transaction. On February 7, 2019 and February 8, 2019, Mr. Shukla, Mr. Pollak, Dr. Dobak and Mr. Kemper received updates from their financial advisors on the progress of the proposed PIPE financing.

On February 13, 2019, after consultations with Constellation, representatives from Cowen and Company, LLC, or Cowen, contacted Dr. Dobak to propose a revised valuation and cash condition to closing. Between February 13, 2019 and March 5, 2019, DermTech and Constellation undertook extensive negotiations to determine a new capital and valuation structure that was acceptable to both parties. The discussions included negotiations to restructure outstanding fees owed to the underwriters in connection with Constellation’s initial public offering. On March 9, 2019 the parties reached an agreement in principle on the proposed structure, valuation, minimum capital requirement, outstanding banking fees and future banking support.

 

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Between March 9, 2019 and March 13, 2019, Dr. Dobak updated DermTech’s board of directors and certain DermTech stockholders as to the merits of the agreed upon transaction, the need for access to public capital markets and the costs associated with becoming a public company, as well as various financing alternatives.

On March 13, 2019, the DermTech board of directors conducted a telephonic discussion to approve the signing of a revised non-binding letter of intent, or the Revised LOI, and the press release announcing the Revised LOI, at which time the DermTech board of directors agreed to proceed with the Revised LOI and the press release.

On March 14, 2019, Mr. Shukla briefed the board of directors of Constellation on the potential business combination with DermTech and execution of the Revised LOI, at which time the board of directors agreed to proceed with the Revised LOI and issuance of the press release. On March 15, 2019, Constellation issued the press release announcing the Revised LOI. On March 21, 2019, representatives of Cowen, Greenberg Traurig, LLP, or Greenberg, counsel to Constellation, and Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., or Mintz, counsel to DermTech, discussed various legal related matters in connection with the proposed merger.

During the period from March 16, 2019, and until May 22, 2019, Constellation continued its financial and legal due diligence on DermTech and Greenberg and Mintz negotiated the terms of the Merger Agreement, including the termination provisions, the amount of the termination fee and the treatment of DermTech’s outstanding stock options, restricted stock units, warrants and convertible notes.

On May 2, 2019 and May 15, 2019, representatives of Cowen provided an update to Mr. Shukla and Mr. Pollak, Dr. Dobak and Mr. Kemper, and representatives of Greenberg and Mintz, regarding to the status of the proposed PIPE financing. By separate conference call on May 9, 2019, representatives of Cowen discussed the marketing efforts with regard to the proposed PIPE financing with Mr. Shukla, Mr. Pollak and representatives of Greenberg.

On May 22, 2019, the board of directors of Constellation unanimously approved (i) the Merger Agreement and the transactions contemplated by the Merger Agreement and (ii) the PIPE and related Subscription Agreements. Constellation executed the Subscription Agreements for the PIPE financing on May 22, 2019 and May 23, 2019. The Merger Agreement was executed on May 29, 2019 by the parties and Constellation and DermTech jointly issued a press release announcing the entering into the Merger Agreement. On May 29, 2019, Constellation filed a Current Report on Form 8-K announcing the execution of the Merger Agreement and the Subscription Agreements and disclosing the key terms of the Merger Agreement and the Subscription Agreements.

DermTech Reasons for the Business Combination

The following discussion sets forth material factors considered by the DermTech board of directors in reaching its determination to authorize the business combination, including the merger; however, it may not include all of the factors considered by the DermTech board of directors. In light of the number and wide variety of factors considered in connection with its evaluation of the business combination, including the merger, the DermTech board of directors did not consider it practicable to, and did not attempt to, quantify or otherwise assign relative weights to the specific factors it considered in reaching its determination. The DermTech board of directors viewed its position and determinations as being based on all of the information available and the factors presented to and considered by it.

In the course of reaching its decision to approve the merger, the DermTech board of directors consulted with its senior management, financial advisor and legal counsel, reviewed a significant amount of information and considered a number of factors, including, among others:

 

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the DermTech board of directors’ belief, after reviewing the various alternative transactions that were considered by the DermTech board of directors and the likelihood of achieving any of these alternative transactions, that currently no alternatives to the merger were reasonably likely to create greater value for DermTech’s stockholders than the merger;

 

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the expectation that the merger would be a more time and cost effective means to access capital than other alternatives considered, including an initial public offering of DermTech’s common stock and additional financings of DermTech as a non-publicly traded entity;

 

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the potential for access to public capital markets following the business combination, including sources of capital from a broader range of investors to support the continued development and commercialization of DermTech’s products than it could otherwise obtain if it continued to operate as a privately-held company;

 

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historical and current information concerning DermTech’s business, including its financial performance and condition, recent publishing of the draft Medicare coverage policy and desire to scale the commercial effort around this coverage, operations, ongoing clinical trial efforts for its current product candidate, management and prospective competitive position;

 

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the cash resources of the combined company expected to be available at the closing of the business combination relative to the anticipated burn rate of the combined company;

 

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the potential to provide DermTech’s current stockholders with greater liquidity by owning stock in a public company;

 

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the fact that the shares of Constellation common stock issued to DermTech stockholders will be registered pursuant to a registration statement on Form S-4 by Constellation and will become freely tradable for DermTech’s stockholders following the expiration of the 180-day lock-up period provided for by the Lock-Up Agreement;

 

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the ability to obtain a NASDAQ listing and the fact that Constellation will change its name to “DermTech, Inc.” upon the closing of the business combination;

 

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the competitive market conditions private companies currently face when seeking exchange traded merger or business combination partners;

 

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the belief, after conducting due diligence, that Constellation had comparatively fewer and less significant ongoing obligations and material liabilities when compared to other potential exchange traded merger and business combination partners;

 

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the likelihood that the merger will be consummated on a timely basis; and

 

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the terms and conditions of the Merger Agreement, including, without limitation, the following:

 

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the expectation that the merger will be treated as a reorganization for U.S. federal income tax purposes, with the result that the DermTech stockholders will not generally recognize taxable gain or loss for U.S. federal income tax purposes upon the exchange of DermTech capital stock for Constellation common stock pursuant to the merger;

 

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the Stockholder Support Agreement, pursuant to which certain stockholders of DermTech, have agreed, solely in their capacity as stockholders of DermTech, to vote all of their shares of DermTech capital stock in favor of the adoption or approval, respectively, of the Merger Agreement and the transactions contemplated by the Merger Agreement; and

 

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the belief that the other terms of the Merger Agreement, including the parties’ representations, warranties and covenants, and the conditions to their respective obligations in these agreements, were reasonable in light of the entire transaction.

The DermTech board of directors also considered a number of uncertainties and risks in its deliberations concerning the merger and the other transactions contemplated by the Merger Agreement, including the following:

 

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the possibility that the merger might not be completed and the potential adverse effect of the public announcement of the merger on the reputation of DermTech and the ability of DermTech to obtain financing in the future in the event the merger is not completed;

 

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