Item 1. Business

Development of Our Business

Oncocyte is a molecular diagnostics company focused on developing and commercializing proprietary tests, initially offered as laboratory-developed tests (“LDTs”), to serve unmet medical needs across the cancer care continuum. Our tests aim to provide actionable information to physicians and patients at critical decision points to optimize treatment decisions, including the selection of immunotherapy, targeted therapy and blood-based treatment monitoring to improve patient outcomes, and reduce overall cost of care.

We have completed three strategic asset and business acquisitions during 2019, 2020 and early 2021 that transformed Oncocyte into a company with a broad menu of laboratory-developed tests that physicians may use at different critical decision points in cancer diagnosis and treatment to support decision-making. In the cancer space, physicians utilize DNA and RNA based testing, also known as molecular testing, to inform treatment decisions for patients diagnosed with cancer. Increasingly, physicians are also performing blood-based molecular testing multiple times during the course of a patient’s treatment, also known as monitoring, to detect response or lack of response to therapy in order to make early and timely changes in patient management. We believe that our menu, which includes proprietary tests for treatment selection (DetermaIO^TM), and blood-based monitoring detecting cell-free derived tumor DNA (DetermaCNI™), will enable the physician to better manage their patient’s disease from diagnosis through monitoring and deliver a significant source of corporate differentiation in the LDT space. We believe that our effort to provide clinically actionable tests for certain key decision points along the continuum of patient management (shown below) will mitigate the inherent risk of being a single product company and should lead to greater revenue opportunities in rapidly emerging markets in cancer treatment.

As part of the strategy to become relevant in the broader diagnostic continuum, we launched DetermaRx^TM via our acquisition of in Razor Genomics, Inc. (“Razor”) in September 2019. DetermaRx™, is the first and only test to predict patient’s risk of cancer recurrence following surgery and response to chemotherapy in early-stage lung cancer, and is our first test to be commercialized and reimbursed by Medicare. DetermaRx^TM serves an unmet clinical need by helping to guide treatment decisions given the 30-50% mortality rate in patients in the absence of timely chemotherapy treatment. During February 2021 we acquired all outstanding shares of Razor common stock which is now a wholly owned subsidiary of Oncocyte.

In January 2020, we acquired Insight Genetics, Inc. (“Insight”) which significantly expanded our product pipeline by adding DetermaIO^TM, a proprietary gene expression assay that is designed to classify the tumor immune microenvironment and identify patients most likely to respond to immune checkpoint inhibition (ICI). The clinical utility of this test is supported by data in hundreds of patients across multiple cancers, including Lung, Breast, Bladder and Kidney cancers and using diverse ICI agents including Keytruda (pembrolizumab), Tecentriq (atezolizumab), Opdivo (nivolumab). This class of drugs are now approved for 16 different cancers and more than one million patients are estimated to be eligible annually in the United States alone. The worldwide market opportunity is 4.1 million patients. However, the response prediction based on treatment selection using currently available biomarkers like PD-L1 and TMB to ICI treatment is not very accurate. DetermaIO^TM addresses the unmet need for a test that can improve upon the performance of these tests in better identifying responders and non-responders to immunotherapies. In clinical studies, DetermaIO^TM has showed 41% higher response (PFS) compared to standard of care biomarker (PD-L1). Compared to TMB, DetermaIO^TM identified up to 30% more patients and compared to PD-L1, DetermaIO^TM identified up to 20% more patients who benefited from Immune Checkpoint Inhibitors (ICI). This test has now been commercialized via an Early Access Program.

During February 2021, we and our newly organized wholly owned subsidiary CNI Monitor Sub, Inc. entered into an Agreement and Plan of Merger (the “Chronix Merger Agreement”) pursuant to which, in April 2021, we acquired Chronix Biomedical, Inc. (“Chronix”) through a merger of Chronix with our subsidiary. By acquiring Chronix, we added Chronix’s TheraSure™-CNI Monitor to our diagnostic test pipeline. The CNI Monitor, which we plan to market as DetermaCNI™, is a patented, blood only test for treatment response monitoring. Oncocyte’s DetermaCNI^TM is a test used to measure and monitor cancer treatment success by detecting changes in circulating tumor DNA (ctDNA) levels, a minimally-invasive biomarker, during the course of treatment. The test is differentiated from other currently used methods because it does not require an upfront tissue sample, which can be hard to obtain, and also provides a genome-wide assessment as opposed to evaluating a subset of genes. Current tests that monitor Minimal Residual Disease measure the amount of cfDNA in a patient’s blood post-surgery to determine if there is a chance for recurrence, where as, DetermaCNI^TM measures Copy Number Instability to monitor whether the disease is progressing and help determine whether the treatment is having the intended impact on a patient’s tumor. The test converts cell-free DNA (cfDNA) next-generation sequencing (NGS) results into a proprietary genome-wide copy number instability (CNI) score which can be used to monitor and guide ongoing treatment decisions. This test is differentiated from other monitoring tests in two ways. The first is that it does not require tumor tissue upfront which can be hard or impossible to obtain. The second is that the test measures copy number variation across the whole genome as opposed to existing tests that focus on mutations identified in a patient’s diagnostic biopsy specimen. This test is supported by several publications including a publication for detecting progression on immunotherapy, and detecting recurrence in patients with ovarian cancer following surgery. Our initial focus will be to offer the CNI Monitor for research use and pharma trials. Our ultimate goal will be to establish the CNI Monitor for clinical use as a blood-based monitoring test.

In addition to the CNI Monitor, Chronix has certain IP-protected organ transplant technology, which enables a precise quantification of donor-derived cell-free DNA (dd-cfDNA) using digital PCR. dd-cfDNA monitoring after solid organ transplantation is a well published technology that has been shown to aid in the early detection of transplant rejection. Chronix has published clinical validation in large cohorts of kidney, liver and heart recipients. Chronix has laboratory operations in Germany that can support the continued development and commercial launch of the Therasure ™ CNI Monitor, Therasure ™ Transplant Monitor and other tests, including our DetermaRx™ and DetermaIO™, in Germany and other EU member countries after the merger.

The Cancer Care Continuum

The cancer care continuum that is the focus of our business can be divided into three important components of information that physicians require to manage their patients through the full term of cancer care:

This three-component continuum represents a large unmet total available market or TAM in the United States and the rest of the world as reflected in graphic below. Oncocyte’s mission is to address the second and third components of the continuum after cancer has been diagnosed, with the goal of ensuring that each patient has the best chance for disease free survival.

Since the advent of genomic scale characterization of cancer, oncologists have strived to apply genomic targeted testing to improvement in selection of treatment and management of disease progression. We are initially applying a comprehensive targeted approach to lung cancer where management paradigms are most mature and believe a similar approach will have utility across solid tumors grounded in their common features in responding to immune therapy. Our first indication for commercialization is lung cancer which remains the leading cause of cancer death in the United States and the rest of the world, making it one of the largest molecular diagnostic market opportunities.

While our sales efforts currently focus on physicians managing patients with lung cancer, the pipeline of tests we plan to offer in the future will expand to all solid tumors and, strategically, our clinical studies and trials with pharma companies will not be limited to lung cancer given the early success of our test in other solid tumors. Our proprietary diagnostic tests are focused on the interrogation of RNA signatures, the coding component that converts DNA code into actual protein production within a cell, from tumor tissue or peripheral blood samples and target key clinical questions that are critical to better management of cancer, from treatment through monitoring of therapeutic efficacy and recurrence of certain cancers. As we expand the scope of our test offerings towards the goal of addressing more key clinical decision points in lung and other cancers, we remain technology agnostic, and aim to continue to identify tests that allow us to reduce to practice the findings from large scale genomic profiling leading to the best approach that addresses the needs of patients and physicians in a manner consistent with the need for rapid turnaround time and judicious use of precious tumor tissue or blood samples while delivering good health economic outcomes.

Our primary growth engines are tests that are novel and proprietary. Through our strategic acquisitions, we have added significant bioinformatics expertise in algorithm development and validation that we can use to analyze functional gene expression and other biological data in order to develop tests that address significant clinical challenges that have not been successfully addressed by currently available technologies. At the same time our tests are run on instruments with a high global installed base enabling decentralization of testing to labs worldwide.

Business Strategy

Why Treatment Selection in Cancer

Approximately 1.8 million people were diagnosed with cancer in 2020 in the United States, and an estimated 17 million worldwide, according to the American Cancer Society. Despite the advancements in therapeutics, cancer remains the second leading cause of death in the United States. Biomarkers are playing an increasingly important role in helping pharmaceutical companies and oncologists identify and select patients for established and new therapies to ensure the right patient gets the right treatment as early as possible post-diagnosis, in order to best improve patient outcomes.

We are building Oncocyte to be a “one stop lab” for treatment decisions for every patient diagnosed with a solid tumor, by delivering to the treating oncologist proprietary biomarker testing that offers incremental information to inform patient treatment and monitor response to therapy, in combination with the current standard of care testing they order today. Since DetermaRx^TM and DetermaIO^TM would only be offered by Oncocyte, our goal is to become the preferred lab for physicians for both our proprietary tests and more traditional tests otherwise offered by many different labs that we can perform in our CLIA laboratories. An example of this testing would be for a patient diagnosed with lung cancer, for whom standard of care targeting information on EGFR, ALK, PD-L1 would be offered, plus DetermaIO^TM our proprietary test for informing immune therapy decisions, all using the same patient tumor or blood sample. This would allow informed selection of targeted immune-therapy and potentially the need for additional cytotoxic chemotherapy. For the course of treatment, we are developing blood-based monitoring tools to detect non-response or progression on therapy to inform timely treatment changes.

This “one-stop” approach offers several practical advantages. Today, the testing needs of physicians managing cancer patients are met by several specialty reference labs, meaning the physician or hospital must split the sample and send portions to several different labs to complete the various tests needed to accurately diagnose the cancer type and select a therapy. Not only does this process consume a large amount of sparse patient biopsy sample risking depletion of the sample before completing all testing, but also the process can take up to three weeks for the compilation of all the results to make it back to the treating physician to inform therapeutic decision making. All too often in the existing paradigm, patients are committed to a therapeutic approach before all the information is returned from the different clinical labs. Oncocyte’s consolidation of testing modalities will allow the judicious use of limited patient biopsy samples and deliver results to the ordering physician within a more expeditious time frame for optimizing the treatment regimen. Our survey of cancer physicians indicates a significant demand for the attributes of consuming a minimal portion of patient biopsy sample and faster turnaround of testing results.

Our Laboratory Tests — Strategically Addressing Unmet Clinical Questions Across the Cancer Care Continuum

We are developing molecular LDTs that provide physicians information to enable the timely diagnosis and treatment of cancer with the ultimate goal of transforming this deadly cancer to a curable or chronic disease. We believe that the proprietary tests in our product pipeline will allow Oncocyte to be relevant in the early stage of decision making giving us unique access to the sample “tumor block” from the beginning of the diagnostic process, thus allowing us to offer other follow up tests without physicians needing to send patient samples to another laboratory. Although we may sometimes refer to our tests as “diagnostic tests,” our laboratory-developed tests are intended to support and help inform physician decision-making, but are not themselves diagnostic or prescriptive of treatment decisions.

DetermaRx^TM – Treatment selection in early-stage lung cancer

Oncocyte’s first commercially available laboratory-developed test is DetermaRx^TM, the only commercialized predictive molecular test for early-stage adenocarcinoma of the lung. This gene expression-based test provides information that a physician can use to help identify early-stage, surgically resected patients with Stage I and IIA non-squamous non-small cell lung cancer (NSCLC) who are at high-risk of recurrence and may benefit from chemotherapy.

NSCLC of the lung is the most common type of lung cancer accounting for 80% to 85% of incidence. Survival rates for patients diagnosed at an early stage are significantly higher than those for patients whose lung cancer is diagnosed at an advanced stage such as Stage III or Stage IV. Surgery is the standard of care for patients diagnosed with early-stage (Stage I and Stage IIA) lung cancer. Yet even after complete surgical resection, between 30% to 50% of those early-stage patients have a recurrence of the disease. Trials of chemotherapy treatment in early-stage disease have been inconclusive as to whether the early-stage treatment improves outcomes in un-stratified patients. Current guidelines suggest risk stratification and use of adjuvant (post-surgery) chemotherapy in “high-risk” patients. However, the recommendations for assessment of risk are subjective and lack clinical studies that validate their usefulness in informing the use of chemotherapy.

DetermaRx™ is a 14-gene molecular stratification test performed on surgically resected tissue and is indicated for patients with Stage I and Stage IIA NSCLC to help determine who may benefit from adjuvant chemotherapy. Typically, thoracic surgeons or medical oncologists order the test after surgical resection. These surgical samples are processed as formalin fixed and paraffin embedded (FFPE) tissue samples. We receive blocks or scrolls of FFPE samples for testing in our CLIA-certified laboratory. A test report is generated classifying patient risk of recurrence and returned to the ordering physician, generally within 10 business days. This turnaround time enables the treating physician to have the report in time for discussion of a treatment plan with the patient, usually a month after surgery.

The results from the prospective study published in Clinical Lung Cancer 2018 and presented at the North American Lung Conference (NA IASCLC) in 2020 were compelling. Patients who were identified as “high risk” and treated with double platinum chemotherapy had a 3% recurrence rate compared to a 30% cancer recurrence rate in high-risk patients who declined chemotherapy.

We believe that there is an annual U.S. market opportunity of approximately 40,000 patients or approximately $126 million for DetermaRx™ based on our reimbursement levels approved by CMS in 2021. This market is expected to grow as high-risk screening recommendations are adopted, resulting in more patients being screened through Low Dose CT (LDCT) scans and diagnosed at an early stage. The European market presents a similar number of patients per year, while China represents the largest patient population with over 250,000 early-stage lung cancer cases per year.

DetermaRx^TM has been validated in three independent cohorts with close to 1,400 patients and test data has been published in top-tier peer reviewed publications including Lancet Oncology, JAMA, and the Journal of Thoracic Oncology. Importantly, the impact of the use of chemotherapy in high-risk patients was demonstrated in a paper published in Clinical Lung Cancer in 2017. We have also initiated an international prospective definitive clinical trial randomizing molecular high-risk patients to adjuvant chemotherapy or surgical intervention alone in order to gather the highest level of evidence supporting the predictive information of DetermaRx^TM. If successful, this study will strongly support access to the entire global market, including countries whose regulatory entities require the most stringent evidence for test reimbursement or marketing.

DetermaIO^TM – Immunotherapy treatment selection

For patients diagnosed with cancer, immunotherapies, particularly immune checkpoint inhibitors (ICI’s) targeting PD-1 and PD-L1, drug class that helps recruit the body’s immune system to attack the growing tumor. ICIs are approved in 16 different tumor types and it is estimated that 4.1 million patients are eligible for these drugs in the US alone. Pharmaceutical companies are continuing to invest heavily in this space, with hundreds of clinical trials ongoing, and a number of drugs approved by the FDA for all solid tumors, including pembrolizumab (Keytruda^TM), nivolumab (Opdivo^TM), and atezolizumab (Tecentriq^TM).

Through the acquisition of Insight in January 2020, Oncocyte has expanded its portfolio to include a novel gene expression-based test called DetermaIO™, which is being developed to identify patients most likely to respond to immunotherapy drugs. Current predictive biomarkers, including PD-L1 and Tumor Mutational Burden or TMB, have shown only limited ability to accurately predict which patients will respond to an immunotherapy. For example, according to published literature, more than half of PD-L1 positive patients do not respond to immune- checkpoint inhibitors, and 1 in 6 patients who will respond are missed (referred to as a “false negative”).

While ICIs represent a significant advancement in treatment options for patients diagnosed with advanced solid cancers, the response rates have been modest, based on treatment directed by the current standard of care biomarker PD-L1 immunohistochemistry. Depending on the solid tumor type, only approximately 15% to 40% of PD-L1 positive tumors respond to ICIs, while a significant number of PDL-1 negative patients do respond. Another issue with ICIs is that although ICI treatments can be highly effective in the right patients, ICI’s also have significant side effects which include exacerbation of latent autoimmune disorders. There is a compelling medical and health economic unmet need for a biomarker that can provide three improvements to the use of ICIs: (1) the identification of additional patients who may respond to the treatment and missed by the existing biomarkers, (2) enable additional or alterative treatment options for the 60% to 85% of patients who may receive these expensive drugs without benefit but while still facing the risk of side effects associated with ICIs, and (3) inform the use of ICI’s in combination with traditional cytotoxic chemotherapy to enhance response rates.

DetermaIO^TM represents an opportunity to enter a very large market to help identify patients who will respond to immune therapy, with more than 750,000 U.S. patients eligible for ICI therapy annually and growing with expanding indications for this type of treatment. As depicted in the image below, analyst predict the ICI spend in the US alone will exceed $125 billion by 2025 meaning the healthcare system will deploy well over $60 billion on drug therapies that will offer no benefit to many of the patients who would receive ICI therapy.

DetermaIO^TM is a proprietary molecular test that has proven in multiple clinical studies, including a gold-standard randomized clinical trial (RCT) to provide incremental utility beyond the current tests being used to identify patients who will have a response to ICIs, and represents a solid opportunity to provide better information for patient management leading to better patient outcomes as well as saving the healthcare systems in the US significant cost. The test has been successfully validated in four tumor types and across all four major ICIs (Keytruda, Opdivo, Tecentriq and Imfinizi). In clinical studies DetermaIO^TM Showed 41% higher response (PFS) compared to standard of care biomarker (PD-L1). Compared to the other commonly used biomarker, Tumor Mutational Burden (TMB), DetermaIO^TM identified up to 30% more patients, and compared to PD-L1, DetermaIO^TM identified up to 20% more patients who benefited from Immune Checkpoint Inhibitors (ICI We completed the CLIA validation of DetermaIO™ in April 2020 and launched the test for research use. The test was launched via an Early Access Program in the fourth quarter of 2021. There are approximately 3,000 PD-1/PD-L1 targeted therapy clinical trials ongoing that are expected to recruit over 500,000 patients. This represents a potential $1 billion market opportunity for immune-therapy clinical trial services to pharma companies developing ICIs which could be addressed by our Pharma Services operations

We also believe, based on our projected reimbursable pricing model, that the clinical use of DetermaIO^TM will address a potential $3 billion TAM opportunity. The actual TAM for DetermaIO™ in medical practice will depend upon a variety of factors including our ability to demonstrate the efficacy and clinical utility of the test, the extent of physician acceptance of the test, whether the test will be approved for Medicare reimbursement, and, if reimbursement is approved, the actual approved reimbursement price.

How DetermaIO^TM May Inform the Choice of Therapies

Despite the potential benefit of immunotherapy, the treatment is very costly, while only a fraction of patients respond, and the treatment is associated with side effects including emergence of autoimmune disorders. There is a pressing need to more accurately identify responders and non-responders to maximize optimize use of the therapies in responders while reducing its use in likely non-responders. DetermaIO™ was developed for that purpose. The test measures the expression level of twenty-seven selected genes which are interpreted through the use of a proprietary algorithm (patent pending) which computes a quantitative score that incorporates information from the immune inflammatory infiltrates within and around the tumor combined with information from the wound response surrounding the tumor. An established threshold is used to classify patients as likely responder or likely non-responder whose association with response to immune therapy has now been validated in several independent clinical studies in multiple different cancer types.

The diagram below reflects the importance of the biology of the tissue immune micro-environment and explains why we believe DetermaIO^TM is an important breakthrough complimenting the current therapy decision process for physicians considering immune checkpoint inhibitors. The figure depicts that every individual forms tumor cells during their lifetime, but our immune system recognizes these abnormal cells and attacks and removes them keeping them from growing into a clinically relevant cancer. When the immune system is over-active and reacts to normal cells, it results in autoimmune disorders. The balance between killing these near normal tumor cells and normal cells is called immune homeostasis and is largely governed by biologic systems called immune checkpoints. When tumors cells disrupt these checkpoints and overwhelm the immune system, a cancer develops. One mechanism by which tumor and the immune system regulate the intensity of immune surveillance is through modulating expression of PD-1 and PD-L1 that together regulate the activity immune effector cells. ICI therapeutics have been developed that block these receptor sites and allow the immune system to once again “see” the tumor and attack and restore the immune system’s ability to kill cancer cells. Because these drugs work on immune cells regardless of their targets, the side effects of these drugs can be enhanced autoimmunity. Unfortunately, response rates to ICI’s are only approximately 15% to 40% depending upon tumor type. However, responses are often durable although resistance does evolve during treatment in some patients. The early success of these drugs has stimulated deeper investigation into the mechanism by which tumors evade the immune system which has revealed a complex interplay between tumor evasion strategies, the activity of immune effector cells and the tissue repair mechanisms that modulate anti-tumor activity. The balance between signal from the tumor, signals from the inflammatory cells invading the tumor, and signals from the wound response are now understood to account for resistance to ICI’s and are the target of second-generation therapeutic strategies to overcome resistance.

DetermaIO^TM was developed to measure the status of the immune system in immune and wound response tissue surrounding tumors. It incorporates measurement of the complete microenvironment including activity of genes expressed in immune effector cells, genes expressed in activated wound response cells, and in some cases, genes expressed by the tumor itself. It is the combination of measurement of these three signals that we believe distinguishes DetermaIO^TM from most other approaches. Current biomarkers being used to assess the likelihood of immune response have shown only modest ability to predict responses to ICI’s. PDL-1 immunohistochemistry looks at the presence of PDL-1 receptors and tumor mutation burden (TMB) at the number of mutations (neoantigens) in the tumor genome. We believe DetermaIO^TM is a direct measure the status of the immune microenvironment and as such identifies those tumors poised to respond to the addition of ICI’s. We believe and now have data to support that the integration of the signal from the “Hot” component of the tumor with the “Cold” immune repressive features, and in some cases the exclusion of immune cells altogether, the immune desert, is superior to measuring any of these physiologies alone.

The ability to accurately determine response to immunotherapies has important implications for both the patients themselves and the healthcare economy as a whole. For the patients that are likely to respond to immunotherapies, these drugs can be a much more effective and less toxic treatment option than standard chemotherapy. For the patients who are unlikely to respond, opting for a different course of treatment would eliminate exposure to potentially serious side effects such as autoimmune diseases, and could save payers in the healthcare industry use of extremely costly therapy regimens. The market continues to seek a test that is predictive, uses very little tissue, and can be performed rapidly. We believe DetermaIO™ meets all the important criteria for a precision medicine test that can be routinely use.

The origin of the gene expression classifier used in DetermaIO™ was work done to better classify triple negative breast cancer (TNBC) into four tumor cell subtypes that could be modified by the immune classifier. It started with a greater than 2200 gene unsupervised classifier that recognized both the physiological differences between tumor types within TNBC, and the activated immune and stromal signatures characteristic of advanced cancers. The original development team from Insight had success reducing the large gene signature to a 101-gene panel for classification of TNBC, and then recognized that the only twenty-seven RNAs from the tumor could provide the appropriate classification of the immune environment that has now matured into DetermaIO™, our CLIA certified PCR test for immune response classification. Since this immune classifier relies upon gene expression signatures derived primarily from inflammatory cells and activated stromal cells, there is no reason to assume that DetermaIO^TM’s immune classification function would be limited to only these tissue types. This prompted our work in lung cancer where the unmodified classifier performed very similarly to breast cancer. We are working to validate the classification function and classifier threshold using publicly available gene expression datasets and testing the classifier as a predictor of response to ICI therapy in other solid tumor types.

Blood Based Monitoring Opportunity

The next emerging opportunity in cancer diagnostics is in the area of therapy response monitoring Analysts have estimated a worldwide TAM ranging from $5 billion to $10 billion for monitoring for therapeutic efficacy and disease recurrence. Monitoring is a “repeat” testing opportunity and given the limitations of current standard of care, CT/MRI imaging, there is an emerging and potentially large market for a blood-based test that can inform a treating physician that a tumor is becoming resistant to a patient’s current treatment protocol before an imaging technique can detect whether there is shrinkage in a tumor. Our mission is to provide relevant, high value information from our menu of tests to treating physicians throughout the “patient journey” for people with lung cancer and other solid tumors. DetermaRx^TM and DetermaIO^TM were developed to help physicians choose the right therapy, and our entry into blood-based monitoring is a natural addition to our test menu to help physicians understand whether their therapeutic choice is working for their patient and to help them make appropriate changes to a patient’s protocol if the tumor is non-responsive. Once the patient’s tumor resolves and they become “Disease Free”, monitoring for recurrence 3 to 4 times a year using a simple blood test could become a way to help turn cancer into a chronic disorder versus a deadly disease, an important part of our corporate mission.

Most approaches to blood-based detection and quantitation of tumor load involve genome scale sequencing of a patient’s tumor to identify “personal” mutations in the tumor and then develop a custom NGS panel assay to monitor for those mutations in each patient’s blood. This process requires significant investment in time and money upfront and complicated infrastructure to manage these “tumor informed” personalized custom panels. We believe there is an opportunity to develop tests that do not require this personalization and therefore eliminate the burdensome tissue requirement and shorten the time to initiate therapeutic monitoring. With our acquisition of Chronix, we added to our test pipeline their Therapy Monitoring solution, TheraSure CNI, which we expect to market as DetermaCNI^TM in the United States. This new monitoring test does not require tumor sequencing prior to blood testing therefore is intended to be an alternative to the tumor informed approach that requires a tissue biopsy. Chronix also brings to Oncocyte a world class assay development team with deep experience and a portfolio of intellectual property in the field of digital-PCR based detection of DNA in blood that will be the foundation for development of our next generation tumor monitoring products.

We are currently in the process of transferring the technology to our CLIA lab in Nashville and expect to finalize the technology transfer in Q2 2022.

Through our acquisition of Chronix we gained access to two patents in the field of the detection and quantification of donor derived cell-free DNA (dd-cfDNA) in patients after organ transplantation. dd-cfDNA has been shown to be a very useful addition to the traditional surveillance of graft health after transplantation and is currently reimbursed in the United States under a blanket LCD document. In September 2020, the United States District Court for the District of Delaware declared three patents in the field of dd-cfDNA (US 8,703,652, 9,845,497 and 10,329,607) invalid, which cleared a year’s long patent infringement case and potentially removes barriers that we may face in the diagnostic field. In October 2021, our patent filing for the use of digital PCR to quantify dd-cfDNA was issued by the USPTO. The issuance of our final patent gave us confidence that we have a patent protected test that has advantages over the current tests in use today and since the assay is already clinically validated in the three major solid organ transplant types (kidney, liver and heart) by peer reviewed international publications, we also believe that we will receive reimbursement approval after a successful technology transfer to our laboratory in Nashville, which is planned to be finalized by the end of Q1 2022. Given the combination of reimbursement likelihood and patent protection, management and the board made the decision to go direct in the US market as an LDT test and seek a platform partner to ultimately provided a regulated, kitted product allowing greater decentralization and better patient access.

Commercialization of our Molecular Diagnostic Tests

Our first commercial diagnostic test is DetermaRx™ which we began to commercialize in 2020. We are presently performing the DetermaRx^TM tests at our CLIA certified laboratory in Irvine. We also have a CLIA certified laboratory and Pharma Services lab in Nashville, Tennessee, which is intended to serve as our Immune Diagnostic Center of Excellence, and, through the Chronix merger in April 2021, we acquired and operate our Blood Based Monitoring Center of Excellence from Göttingen, Germany.

As of December 31, 2021 we had a sales team of eleven that have been hired in the geographical regions with the highest volume of thoracic surgeries who have extensive experience selling high value oncology molecular tests, and a medical education team which includes a board-certified genetic counselor. The product was launched to seven Early Adopter Sites in February 2020 to establish and test our CLIA lab protocols and workflows, gain customer feedback on the final patient report and validate our logistical plan for sample transport. The decision was made to enter a full market launch in late February 2020 after successful validation of our processes, and full engagement started in early March. To expand our customer base for DetermaRx™, we have hired a limited sales force in focused regions of the country to identify and target hospitals and physicians that perform a high volume of surgical resections, which include large group practices (LGPs), as well as National Comprehensive Cancer Network (NCCN) and NCI cancer centers. Our primary call point is thoracic surgeons because they manage most early-stage lung cancer patients, and refer patients to medical oncologists for further treatment post-surgery as needed. Our sales representatives also call on medical oncologists who make the chemotherapy treatment decision for patients identified high-risk by the test. These are complimentary call points as often decisions to adopt a test are made by a multi-disciplinary team. Unfortunately, the world was facing the emergence of a pandemic of a Novel Coronavirus, called SARS- CoV2, which ultimately led to the COVID-19 pandemic that severely impacted our sales forces’ ability to engage new accounts and surgeons in person at the critical early phase of full market launch. In late March 2020, our medical education team pivoted to a virtual training program and began to offer Medical Education events over virtual calls and video meetings which allowed our sales representatives to set up virtual presentations to educate physicians about DetermaRx^TM. We believe the program was successful because through the end of 2021, the virtual programs had reached over 5,000 healthcare professionals.

Since our broad commercial launch in March 2020, DetermaRx^TM has now been ordered at more than 183 hospitals and by 213 physicians in the United States. The strategy we are pursuing to market DetermaRx™ is likely to be replicated in large measure for the market launch of our other cancer tests as we complete test development.

In December 2020, we entered into an Exclusive Sublicense Agreement in the PRC Territory (the “Sublicense Agreement”) with Burning Rock Biotech Limited (“Burning Rock”), Razor and Razor’s largest shareholder Encore Clinical Inc. pursuant to which rights to DetermaRx™ in the Peoples Republic of China, including Hong Kong, Macau, and Taiwan are sublicensed to Burning Rock. Under the Burning Rock Sublicense Agreement, we are entitled to receive certain payments (the “Initial Milestone Payments”) totaling $4 million subject to the successful transfer and installation of the DetermaRx™ technology on Burning Rock’s platforms, and additional payments if certain milestones are achieved and running royalties. As of December 31, 2021, we have received $3 million of the Initial Milestone Payments.

We are investing in physician education to drive demand for DetermaRx™. A central pillar of our physician education efforts is our Key Opinion Leader-led speaker program that is focused on peer-to-peer engagement. We have 16 community and academic speakers representing DetermaRx™ in commercial peer-to-peer programs. Our marketing and physician education efforts also include participation in lung cancer focused national and regional medical meetings and symposia, and grant support of accredited continuing medical education (CME) events. In 2021, we held six national-level KOL engagement activities and 85 speaker programs, including a CME event at the San Antonio Breast Cancer Symposium chaired by KOL Hope Rugo from UCSF, and Adam Brufsky, among others. Lastly, we held six Regional Perspectives In Early-stage Lung Cancer programs that bought together regional KOLs to discuss real-world use cases of DetermaRx™ and its impact on patient care.

Market Access – Reimbursement

Billing, Coverage, and Reimbursement for our Diagnostic Tests

Currently DetermaRx^TM is Oncocyte’s only commercialized clinical test. We expect that revenues from our clinical laboratory for this test will be derived from several different sources:

In August 2020, Noridian Healthcare Solutions, LLC, CMS’ Medicare Administrative Contractor (“MAC”) for laboratories located in California, delivered a final coverage and pricing decision. This decision and coverage by other MACs is important because approximately 70% of patients for whom the test is indicated are eligible for Medicare coverage. However, in the absence of reimbursement by a health insurance plan or Medicare, patients who would be candidates for the use of our tests may decline to use our tests, and physicians may be reluctant to prescribe our tests, due to the cost of the test to the patients. Because of this patient cost factor, revenues from any new cancer test that we market may experience slow growth until the test is approved for reimbursement by larger payer plans which cover many patients.

Medicare

For cancer diagnostics, Medicare or CMS reimbursement approval is critical. CMS relies on a network of Medicare Administrative Contractors (“MACs”) to make Local Coverage Decisions approving a test for reimbursement. The Molecular Diagnostics Services (“MolDx”) Program was developed by Palmetto GBA (the previous MAC for California) to identify and establish coverage and reimbursement for molecular diagnostics tests. The program has developed guidelines for the level of evidence of efficacy required to be obtained through clinical trials. Palmetto, which contracted with CMS to administer the MolDx, issues Local Coverage Determinations that affect coverage, coding, and billing of many molecular tests and the current MAC for California, Noridian Healthcare Solutions, LLC, has adopted the coverage policies from Palmetto. MACs also serve as the primary operational contact between the Medicare Fee-For-Service program, for paying Medicare claims, and approximately 1.5 million health care providers enrolled in the program. Delays in obtaining MAC approval, or any changes made related to any favorable Local Coverage Determinations, could have a material adverse impact on our business.

Private Third-Party Payers

In addition to seeking Medicare reimbursement approval, we will seek reimbursement approval from private payers such as health insurance companies and HMOs. Private payers generally will determine whether to approve a diagnostic test for reimbursement based on the published results of clinical validity and clinical utility studies, and may base their decision on whether to cover a test, and at what level to reimburse, on the MAC’s local coverage determination. Obtaining private payer medical coverage generally takes twelve to twenty-four months from the time that sufficient evidence is demonstrated. In the interim we will bill commercial payers and appeal any denials using the published clinical evidence supporting the utility of the test.

Reimbursement rates paid by private third-party payers can vary based on whether the provider is considered to be an “in-network” provider, a participating provider, a covered provider, an “out-of-network” provider or a non-participating provider. Currently, we are out-of-network with all commercial payers. These definitions can vary among payers. An in-network provider usually has a contract with the payer or benefits provider. This contract governs, among other things, service-level agreements and reimbursement rates. In certain instances, an insurance company may negotiate an in-network rate for our testing. An in-network provider may have rates that are lower per test than those that are out-of-network, and that rate can vary widely. Rates vary based on the payer, the testing type and often the specifics of the patient’s insurance plan. If a laboratory agrees to contract as an in-network provider, it generally expects to receive quicker payment and access to additional covered patients. However, it is likely that we will initially be considered an “out-of-network” or non-participating provider by payers who cover the vast majority of patients until we can negotiate contracts with the payers.

We cannot predict whether, or under what circumstances, payers will reimburse for patients for our tests or whether our efforts to appeal denied claims will be successful. While we have a rigorous process for prior authorization and appeals to overturn denials and to get contracted with commercial payers, full or partial denial of coverage by payers, or reimbursement at inadequate levels, would have a material adverse impact on our business and on market acceptance of our tests.

Billing and Collection

Where there is a private or governmental third-party payer coverage policy in place, we will bill the payer and the patient in accordance with the established policy. Our efforts in obtaining reimbursement based on individual claims, including pursuing appeals or reconsiderations of claims denials, could take a substantial amount of time, and bills may not be paid for many months, if at all. Furthermore, if a third-party payer denies coverage after final appeal, payment may not be received at all.

Where there is no coverage policy in place, we will pursue reimbursement on a case-by-case basis. In some cases, if not prohibited by law or regulation, we may bill physicians, hospitals and other laboratories directly for the services that they order. However, laws and regulations in certain states prohibit laboratories from billing physicians or other purchasers for testing that they order. Some states may allow laboratories to bill physicians directly but may prohibit the physician and, in some cases, other purchasers from charging more than the purchase price for the services, or may allow only for the recovery of acquisition costs, or may require disclosure of certain information on the invoice. An increase in the number of states that impose similar restrictions could adversely affect us by encouraging physicians to perform laboratory services in-house or by causing physicians to refer services to other laboratories that are not subject to the same restrictions. Adoption or expansion of laws and regulations that limit our ability to bill and obtain reimbursement for the full costs of our services would have a material adverse impact on our business and on market acceptance of our tests.

Corporate Information

We were incorporated in September 2009 in the state of California. Our principal executive offices are located at 15 Cushing, Irvine, California 92618. Our telephone number is (949) 409-7600. Our website is www.Oncocyte.com. Information contained on, or that can be accessed through, our website, is not, and shall not be deemed to be, incorporated into or be considered a part of this Report.

Competition

Our industry is highly competitive and characterized by rapid technological change. Key competitive factors in our industry include, among others, the ability to successfully complete clinical studies, the ability to obtain any required regulatory approval, average selling prices of competing tests, CLIA laboratory capacity and costs, intellectual property and patent rights, and sales and marketing capabilities. We are an early-stage company with a limited operating history and many of our competitors have substantially more resources than we do, including financial, technical and sales resources. In addition, many of our competitors have more experience than we have in the development and commercialization of diagnostics. We are also competing with academic institutions, governmental agencies and private organizations that are conducting research in the field of diagnostics. Our competition will be determined in part by the potential indications for which our lead test candidates are developed and ultimately marketed. Additionally, the timing of market introduction of our diagnostic tests or of competitors’ tests may be an important competitive factor.

For the DetermaRx™ test, Oncocyte is not aware of any other diagnostic test currently on the market for the treatment stratification of patients with surgically resected Stage I and IIA NSCLC, therefore we do not believe there is a direct competitor to our DetermaRx™ test. Guidelines established by the NCCN include criteria for identifying patients at high risk of recurrence for resected Stage I and IIA NSCLC, but these criteria, to our knowledge, have not been validated to demonstrate accuracy or clinical benefit.

The DetermaIO™ test competes with multiple biomarkers already in clinical use or in development for predicting response to immunotherapy. The most commonly used clinical tests employed in the immunotherapy response market are PD-L1 expression testing and TMB. We believe, however, the current standard of care for PD-L1 testing has important limitations. According to published literature, more than half of PD-L1 positive patients do not respond to immune- checkpoint inhibitors, and 1 in 6 patients who will respond are missed (referred to as a “false negative”). Furthermore, data presented at recent oncology medical conferences suggests that TMB is not a reliable predictor of immunotherapy response. Further, data presented at SITC (discussed previously), suggested that DetermaIO™ outperformed both PD-L1 and TMB in predicting response to checkpoint inhibitors in patients with NSCLC. In 2021, we presented data at four major scientific conferences supporting the association of DetermaIO^TM and response to checkpoint inhibitor therapy and comparing to PD-L1 and TMB. Notably data presented at both ESMO and SABCS demonstrated the predictive value of the test.

DetermaCNI^TM competes with tumor-informed tests that are on market for treatment monitoring as well as blood-only targeted panels. We believe we are differentiated from the former in that the test requires no tissue. DetermaCNI^TM is differentiated from targeted approaches because it assesses changes across the whole genome broadly as opposed to changes in a subset of genes and is applicable in both adjuvant and neo-adjuvant patient scenarios versus tests that monitor Minimal Residual Disease (MRD) which are typically only used when the tumor is removed.

Certain Razor Agreements

During February 2021 we acquired all of the shares of Razor common stock from its shareholders. Razor is now a wholly owned subsidiary of Oncocyte. Razor holds an exclusive worldwide license from The University of California San Francisco (“UCSF”) under certain patent rights applicable to DetermaRx™. The license agreement includes certain royalty payment, sublicense revenue sharing, and test development and commercialization milestone provisions. If the development and commercialization milestones are not met in a timely manner, UCSF could convert the license into a non-exclusive license. Royalties payable to the licensor will be in a mid-single digit percentage range depending on the source of revenue. The license agreement will remain in effect until the expiration or abandonment of the last of the licensed patent rights, but would terminate earlier if Oncocyte were to become subject to bankruptcy proceedings or if Oncocyte fails to perform or violates any term of the license agreement and does not cure the breach within the time allotted.

During September 2019, we entered into a Sublicense and Distribution Agreement (“Razor Sublicense Agreement”) with Razor and its then principal shareholder Encore Clinical, Inc. (“Encore”) pursuant to which Razor granted us exclusive worldwide sublicenses under certain patent rights applicable to DetermaRx™ for purposes of commercialization and development of DetermaRx™. Although we have since acquired all of the shares of Razor from its former shareholders, Oncocyte remains obligated on the Razor Sublicense Agreement to pay all royalties and all revenue sharing and earnout payments owed by Razor to certain third parties with respect to DetermaRx™ revenues, including the licensor of the patent rights, but those payments will be deducted from gross revenues to determine net revenues for the purpose of paying royalties to the Razor shareholders. Total royalty and earnout payments to the Razor shareholders, the licensor, and other third parties will be a low double-digit percentage, and in addition certain milestone payments may become due if cumulative net revenue benchmarks are reached. Royalties and earnout payments will be payable on a quarterly basis.

Development Agreement

During September 2019, in connection with our initial investment in Razor, we entered into a Development Agreement that governs certain matters pertaining to a clinical trial of DetermaRx^TM (“Clinical Trial”). The Development Agreement sets forth (i) certain obligations and responsibilities of Oncocyte, Encore, and Razor, with respect to the Clinical Trial, including the obligations of Oncocyte and Razor to pay Clinical Trial costs and expenses, (ii) Encore’s obligation to provide consulting services to Razor and Oncocyte in support of the Clinical Trial, (iii) Oncocyte’s obligation to make certain payments in cash to Encore , and to issue additional shares of Oncocyte common stock to Encore and the Minority Shareholders, upon the attainment of certain Clinical Trial milestones, and (iv) Encore’s entitlement to certain cash payments if certain Clinical Trial funding is received.

Upon completion of enrollment of the full number of patients for the Clinical Trial, Oncocyte will issue to Encore and the other former Razor shareholders shares of Oncocyte common stock with an aggregate market value at the date of issue equal to $3 million. If the issuance of shares of our common stock having a market value of $3 million would require us to issue a number of shares that, when combined with any shares we issued under the Purchase Agreement and the Minority Shareholder Purchase Agreements, would exceed 19.99% of the issued and outstanding shares of our common stock or the outstanding voting power of our shares as of the date of the Purchase Agreement, we may deliver a number of shares of our common stock that would not exceed that combined 19.99% limit and an amount of cash necessary to bring the combined value of cash and shares to $3 million.

If within a specified time frame Encore is substantially responsible for obtaining funding to Oncocyte or Razor for the Clinical Trial from any third-party pharmaceutical company, a portion of such additional funding amount will be paid to Encore, subject to a $3 million cap on the payment to Encore if the funding is provided by a designated pharmaceutical company.

Facilities

Oncocyte leases a building located at 15 Cushing in Irvine, California that serves as Oncocyte’s principal executive and administrative offices and laboratory facility. Oncocyte has constructed a clinical diagnostic laboratory and a research laboratory in the building and has received CLIA certification for the laboratory. Oncocyte also operates CLIA certified laboratories in Nashville, Tennessee. Through the acquisition of Chronix Biomedical, Oncocyte also has a research and development facility in Göttingen, Germany, which serves as the center of excellence for the company’s blood based monitoring program.

Materials

There is a limited number of manufacturers of molecular testing equipment and related chemical reagents necessary for the provision of our cancer tests. Additionally, the chemical reagents used with the testing equipment we chose are available only from the equipment manufacturer. This situation poses a risk to us. After encountering inconsistent results using testing equipment and reagents from one manufacturer, we switched to testing equipment from a different manufacturer. If issues were to arise with the testing equipment or with the reagents we are using, causing us to acquire different testing equipment again, we would need to conduct additional laboratory studies to determine whether our previous test results can be reproduced using the new equipment. If similar issues were to arise after commercialization of a test, we could experience a disruption for a period of time in providing the tests to patients and we would lose revenues and potentially market share as a result.

Patents and Trade Secrets

We rely primarily on patents and contractual obligations with employees and third parties to protect our proprietary rights. We have sought, and intend to continue to seek, appropriate patent protection for important and strategic components of our proprietary technologies by filing patent applications in the United States and certain foreign countries. There can be no assurance that any of our patents will guarantee protection or market exclusivity for our diagnostic tests and diagnostic test candidates. We may also use license agreements both to access technologies developed by other companies and universities and to convey certain intellectual property rights to others. Our financial success will be dependent in part on our ability to obtain commercially valuable patent claims and to protect our intellectual property rights and to operate without infringing upon the proprietary rights of others.

We have certain exclusive rights to patents and patent applications co-owned by our subsidiary Razor and UCSF. The claims are directed to compositions of matter and methods useful for treating and detection of lung cancer using specific biomarkers or a panel of specific biomarkers. Patents covered by the exclusive rights have issued in the United States, Australia, Europe, and Hong Kong with projected expiration dates in 2032 and 2033.

We and Razor also have exclusive sublicense rights to certain patents and patent applications owned by UCSF. The claims are directed to compositions of matter and methods useful for treating and detection of lung cancer using specific biomarkers or a panel of specific biomarkers. Patents covered by the exclusive rights have issued in Australia, Europe, New Zealand, Japan, China, Canada, and Hong Kong and are pending in the United States with projected expiration dates in 2028.

Through our acquisition of Insight Genetics in January 2020 and Chronix in April 2021, we obtained exclusive rights to additional intellectual property, including trade secrets, registered trademarks, domain names, copyrights, issued and reissued patents and pending applications, and software material, and have since the Insight Genetics acquisition filed our own patents to protect DetermaIO^TM.

Through our acquisition of Chronix in April 2021, we obtained intellectual property rights to 10 patent families in the field of detection of cell-free tumor DNA and quantification of donor derived cell-fee DNA, with numerous already issued patents in the United States and European Union, expiring between April 2031 and October 2034. In addition, we obtained trade secrets, registered trademarks, domain names, copyrights and proprietary software material.

In addition to relying on patents, we will rely on trade secrets, know-how, continuing technological advancement, and licensing opportunities to maintain our competitive position. The molecular diagnostics that we are developing use gene expression classifiers or algorithms, which are mathematical models that weight the biomarkers to produce a score. We will treat the mathematical models as trade secrets. We have entered into intellectual property, invention, and non-disclosure agreements with our employees, and it is our practice to enter into confidentiality agreements with our consultants. There can be no assurance, however, that these measures will prevent the unauthorized disclosure or use of our trade secrets and know-how, or that others may not independently develop similar trade secrets and know-how or obtain access to our trade secrets, know-how, or proprietary technology.

General Risks Related to Obtaining and Enforcing Patent Protection

Our patents and patent applications are directed to compositions of matter, formulations, methods of use and/or methods of manufacturing. The patent positions of pharmaceutical and biotechnology companies, including ours, are generally uncertain and involve complex legal and factual questions. Our business could be negatively impacted by any of the following:

In addition, others may independently develop similar or alternative technologies, duplicate any of our technologies and, if patents are licensed or issued to us, design around the patented technologies licensed to or developed by us. Moreover, we could incur substantial costs in litigation if we have to defend ourselves in patent lawsuits brought by third parties or if we initiate such lawsuits.

The United States Supreme Court’s decisions in Mayo Collaborative Services v. Prometheus Laboratories, Inc. and Association for Molecular Pathology v. Myriad Genetics may limit our ability to obtain patent protection on diagnostic methods that merely recite a correlation between a naturally occurring event and a diagnostic outcome associated with that event. Our cancer diagnostic tests are based on the presence of certain genetic markers for a variety of cancers. In Mayo Collaborative Services v. Prometheus Laboratories, Inc., the Supreme Court ruled that patent protection is not available for simple the use of a mathematical correlation of the presence of a well-known naturally occurring metabolite as a means of determining proper drug dosage. The claims in the contested patents that were the subject of that decision were directed to measuring the serum level of a drug metabolite and adjusting the dosing regimen of the drug based on the metabolite level. The Supreme Court said that a patent claim that merely claimed a correlation between the blood levels of a drug metabolite and the best dosage of the drug was not patentable subject matter because it did no more than recite a correlation that occurs in nature.

In Association for Molecular Pathology v. Myriad Genetics, the Supreme Court ruled that the discovery of the precise location and sequence of certain genes, mutations of which can dramatically increase the risk of breast and ovarian cancer, was not patentable. Knowledge of the gene location and sequences was used to determine the genes’ typical nucleotide sequence, which, in turn, enabled the development of medical tests useful for detecting mutations in these genes in a particular patient to assess the patient’s cancer risk. But the mere discovery of an important and useful gene did not render the genes patentable as a new composition of matter.

Also, in Ariosa Diagnostics, Inc. v. Sequenom, Inc., the Federal Circuit ruled that a method for detecting a paternally inherited nucleic acid of fetal origin performed on a maternal serum or plasma sample from a pregnant female was not patent eligible subject matter under the framework set forth in Mayo Collaborative Services v. Prometheus Laboratories, Inc. The court examined the elements of the claim to determine whether the claim contained an inventive concept sufficient to transform the claimed naturally occurring phenomenon into a patent eligible application and found that the method steps did not support patentability because they used conventional amplification and detection techniques. Although the claims can be distinguished from the claims at issue in Mayo Collaborative Services v. Prometheus Laboratories, Inc., the court was bound by the language of the Supreme Court decision to hold Sequenom’s claims unpatentable.

In Illumina, Inc. v. Ariosa Diagnostics, Inc., the Federal Circuit reversed and remanded the lower court and found that claims directed to methods of preparing plasma to isolate extracellular fetal DNA, based on the inventors’ discovery that fetal DNA strands in maternal plasma are relatively short compared to maternal DNA, were directed to patent-eligible subject matter. The majority reasoned that the claimed methods include process steps that lead to a DNA fraction that is different from the naturally-occurring fraction present in the mother’s blood due to enrichment of cell-free fetal DNA. Thus, the process achieves more than simply observing that fetal DNA is shorter than maternal DNA or detecting the presence of that phenomenon. The majority noted that the inclusion of specific techniques for carrying out the steps of the method, illustrated the concrete nature of the claimed process steps. These concrete process steps were used, not merely to observe the presence of the phenomenon that fetal DNA is shorter than maternal DNA, but to exploit that discovery in a method for preparation of a mixture enriched in fetal DNA and thus supported a finding of patent eligible subject matter.

While the cases discussed above are instructive, the United States Patent and Trademark Office (the “USPTO”) has also issued guidelines in light of the Supreme Court decisions indicating that process claims having a natural principle as a limiting step will be evaluated to determine if the claim includes additional steps that practically apply the natural principle such that the claim amounts to significantly more than the natural principle itself. Because the diagnostic tests that we are developing combine an innovative methodology with newly discovered compositions of matter, we are hopeful that this Supreme Court decision will not preclude the availability of patent protection for our diagnostic tests. However, there is no guarantee that such pending patent applications will issue nor that our existing patents would survive a challenge in light of the above-referenced case law.

The USPTO has also issued multiple Subject Matter Eligibility Updates to provide further guidance in determining subject matter eligibility. The Subject Matter Eligibility Updates include new Subject Matter Eligibility Examples for the Life Sciences. These examples provide favorable exemplary subject matter eligibility analysis of hypothetical claims covering diagnostic tests and claims drawn from case law. This update from the USPTO does not change our opinion on our ability to obtain meaningful patent protection.

There is a risk that any patent applications that we file and any patents that we hold or later obtain could be challenged by third parties and declared invalid or infringing of third-party claims. A patent interference proceeding may be instituted with the USPTO when more than one person files a patent application covering the same technology, or if someone wishes to challenge the validity of an issued patent filed before March 16, 2013. At the completion of the interference proceeding, the USPTO will determine which competing applicant is entitled to the patent, or whether an issued patent is valid. Patent interference proceedings are complex, highly contested legal proceedings, and the USPTO’s decision is subject to appeal. This means that if an interference proceeding arises with respect to any of our patent applications, we may experience significant expenses and delay in obtaining a patent, and if the outcome of the proceeding is unfavorable to us, the patent could be issued to a competitor rather than to us. In addition to interference proceedings, the USPTO can review issued patents at the request of a third party seeking to have the patent invalidated. Currently an inter partes review proceeding will allow third parties to challenge the validity, based on issues of novelty and non-obviousness, in view of patents and printed publications, of an issued patent where there is a reasonable likelihood of invalidity. This means that patents owned or licensed by us may be lost if the outcome of the review is unfavorable to us.

Post Grant Review under the America Invents Act makes available opposition-like proceedings in the United States. As with the USPTO interference proceedings, Post Grant Review proceedings will be very expensive to contest and can result in invalidation of a recently issued patent. To invoke a post-grant review, a challenge must be filed within nine months of a patent’s issuance or reissuance. Post-grant review can be sought based on any grounds that can be used to challenge the validity of a patent claim, with the exception of failure to disclose the best mode. Also, a derivation proceeding may be instituted by the USPTO or an inventor alleging that a patent or application was derived from the work of another inventor.

Oppositions to the issuance of patents may be filed under European patent law and the patent laws of certain other countries. As with the USPTO interference proceedings, these foreign proceedings can be very expensive to contest and can result in significant delays in obtaining a patent or can result in a denial of a patent application.

The enforcement of patent rights often requires litigation against third party infringers, and such litigation can be costly to pursue. Even if we succeed in having new patents issued or in defending any challenge to issued patents, there is no assurance that our patents will be comprehensive enough to provide us with meaningful patent protection against our competitors. Further, should we sue a third party infringer for patent infringement, the infringer may assert counter claims and attempt to invalidate some or all of the asserted patent claims. There is always some risk that such a counter claim could result in invalidation of one or more claims of an asserted patent.

Government Regulation

CLIA—Clinical Laboratory Improvement Amendments of 1988 and State Regulation

We expect that DetermaRx™ and DetermaIO™ will be regulated under the Clinical Laboratory Improvements Amendment (“CLIA”) as laboratory developed tests or “LDTs”. In 1988, Congress enacted CLIA, which established quality standards for all laboratories that provide testing services to ensure the accuracy, reliability and timeliness of patient test results regardless of where the test is performed.

Under CLIA, a laboratory is defined as any facility that performs laboratory testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease, or the impairment of, or assessment of health of human beings. Because we meet this definition, CLIA requires that we hold a certificate applicable to the complexity of the categories of testing we perform and that we comply with certain standards. Laboratories performing high complexity testing are required to meet more stringent requirements than laboratories performing less complex tests. CLIA regulations require clinical laboratories like ours to comply 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 a prerequisite for reimbursement eligibility for services provided to state and federal health care program beneficiaries. CLIA is user-fee funded. Therefore, all costs of administering the program must be covered by the regulated facilities, including certification and survey costs.

FDA Regulation of Diagnostic Tests

We have designed, developed, and are validating our tests as LDTs and consequently believe our tests are governed under the CLIA regulations, as administered by CMS, as well as by applicable state laws.

Historically, the FDA had exercised enforcement restraint with respect to most LDTs and had not required laboratories that offer LDTs to comply with FDA requirements for medical devices, such as registration, device listing, quality systems regulations, premarket clearance or premarket approval, and post-market controls.

In recent years, the FDA has stated it intends to end its policy of enforcement restraint and begin regulating certain LDTs as medical devices. In October 2014, the FDA issued two draft guidance documents, entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)”, respectively, that set forth a proposed risk-based regulatory framework that would apply varying levels of FDA oversight to LDTs.

The FDA has indicated that it does not intend to modify its policy of enforcement restraint until the draft guidance documents are finalized. Subsequently, in January 2017, the FDA issued a Discussion Paper on LDTs (“Discussion Paper”), in which it outlined a substantially revised “possible approach” to the oversight of LTDs. The risk-based approach outlined focuses on new and significantly modified high and moderate risk LDTs and low risk LDTs, LDTs for rare diseases, traditional LDTs, LDTs intended solely for public health surveillance, certain LDTs used in CLIA certified labs, and LDTs intended solely for forensic use would not be expected to comply with premarket review, quality systems, and registration and listing requirements unless necessary to protect public health. With respect to the post-market surveillance of LDTs, the FDA’s Discussion Paper recommends that laboratories initially report serious adverse events for all tests except the exempted categories of tests, which include LDTs intended for public health surveillance, some stem cell/tissue/organ transplantation LDTs, and LDTs intended solely for forensic use. The Discussion Paper notes that it is not a final version of the 2014 draft guidance and that it does not intend to represent the FDA’s formal position but rather describes the evolution of the agency’s thinking about the regulatory framework for LDTs.

Responding to the COVID-19 pandemic, in August, 2020, the Department of Health and Human Services (“HHS”), the parent agency for FDA, formally rescinded FDA guidance and other informal statements concerning FDA’s premarket review of LDTs and announced that the FDA “will not require premarket review of [LDTs] absent notice-and comment rulemaking, as opposed through guidance documents, compliance manuals, website statements, or other informal issuances.” It is unclear at this time whether the Biden administration will revise or rescind this policy.

It is unclear at this time when or if the FDA will finalize its plans to end enforcement discretion, via notice and comment rulemaking or otherwise, and even then, new regulatory requirements are expected to be phased-in over time. Nevertheless, the FDA may attempt to regulate certain LDTs on a case-by-case basis at any time.

On June 24, 2021, bi-partisan members of both the House and Senate re-introduced the Verifying Accurate, Leading-edge IVCT Development (“VALID”) Act, which features a precertification program. The term IVCT refers to in vitro clinical tests, a category that w comprises both test kits and lab-developed tests. The VALID Act includes precertification proposed by the FDA, a process through which diagnostic developers could receive premarket approval or clearance for one test representative of a group of tests using the same technology and have other elements in common. Approval of that representative test would precertify other tests in the group and allow the lab to launch them without premarket review. The VALID Act would also create a new system for labs and hospitals to use to submit their tests electronically to the FDA for approval, which is aimed at reducing the amount of time it takes for the agency to approve such tests, and establish a new program to expedite the development of diagnostic tests that can be used to address a current unmet need for patients. The introduced Valid Act also includes specific language designed to address public health emergencies, including COVID-19. If enacted, the impact of the VALID Act will be minimal for IVD manufacturers because of the alignment between the VALID Act and existing medical device statutory and regulatory requirements and the fact that such requirements have been enforced for IVD manufacturers for decades; however, it will have a significant impact on clinical laboratories as laboratories will need to comply with many new requirements, including: registration and listing with the FDA; quality requirements; investigational studies; premarket review and approval; adverse event reporting; and corrections and removals (recalls). While the VALID Act outlines a framework for these elements (among others), the law, if enacted, would direct the FDA to promulgate regulations and issue guidance documents within two (2) years of its enactment, and establishes an effective date for the new IVCT regulatory system as four (4) years after enactment, giving clinical laboratories and others ample opportunity to participate in shaping and preparing for the new IVCT regulatory program.

On May 18, 2021, Senator Rand Paul re-introduced a bill, called the Verified Innovative Testing in American Laboratories (“VITAL”) Act of 2021, which strikes a counterpoint to the proposed VALID Act. VITAL seeks to update existing federal lab standards under the CLIA, specifically stating that all aspects of lab-developed testing procedures would be regulated by the US Health and Human Services Secretary under the Public Health Services Act, and that no aspects of lab-developed testing procedures would be regulated under the Federal Food, Drug, and Cosmetic Act, including during a public health emergency.

While we cannot predict whether the either VALID Act or the VITAL Act as proposed, or any modified version of either act will be enacted into law, it is expected that some form of the acts will be incorporated into a broader health care legislative package. The likelihood that Congress will pass legislation and the extent to which such legislation may affect the FDA’s plans to regulate certain LDTs as medical devices is difficult to predict at this time. Until the VALID Act, VITAL Act, or other legislation is passed reforming the federal government’s regulation of LDTs, it is unknown how the FDA may regulate our tests in the future and what testing and data may be required to support any required clearance or approval.

If the FDA ultimately regulates certain LDTs, whether via final guidance, final regulation, or as instructed by Congress, our tests may be subject to certain additional regulatory requirements. Complying with the FDA’s requirements can be expensive, time-consuming, and subject us to significant or unanticipated delays. Insofar as we may be required to obtain premarket clearance or approval to perform or continue performing an LDT, we cannot assure that we will be able to obtain such authorization. Even if we obtain regulatory clearance or approval where required, such authorization may not be for the intended uses that we believe are commercially attractive or are critical to the commercial success of our tests. As a result, the application of the FDA’s requirements to our tests could materially and adversely affect our business, financial condition, and results of operations.

Notwithstanding the FDA’s current position with respect to oversight of our tests, we may voluntarily decide to pursue FDA pre-market review for our current tests and tests we may offer in the future if we determine that doing so would be appropriate from a strategic perspective.

Failure to comply with applicable FDA regulatory requirements may trigger a range of enforcement actions by the FDA including warning letters, civil monetary penalties, injunctions, criminal prosecution, recall or seizure, operating restrictions, partial suspension or total shutdown of operations, and denial of or challenges to applications for clearance or approval, as well as significant adverse publicity.

State Laboratory Licensing

In addition to federal certification requirements of laboratories under CLIA, we are required to maintain licensure under California law for our laboratory in Irvine, California and under Tennessee law for our laboratory in Nashville, Tennessee. State laws generally include standards for the day-to-day operation of a clinical reference laboratory, including the training and skills required of personnel and quality control. In addition, those laws often mandate proficiency testing, which involves testing of specimens that have been specifically prepared for the laboratory.

Some states require licensure of out-of-state laboratories that accept specimens from those states. Our laboratories will need to pass various state inspections in order to get licensed to provide LDTs in each of state that requires licensure. CLIA provides that a state may adopt laboratory regulations that are more stringent than those under federal law, and two states, New York and Washington, have met that standard and therefore substitute for the federal CLIA program. In addition, some, but not all, states require a separate state license or permit, which must be obtained in addition to a CLIA certificate, and some states require a laboratory doing business in that state to be licensed even if the laboratory is located in another state.

Our laboratories are licensed by the appropriate state agencies in the states in which we do business, if such licensure is required. If a laboratory is out of compliance with state laws or regulations governing licensed laboratories, a state may impose penalties, which penalties vary from state to state but may include suspension, limitation, revocation or annulment of the license, assessment of financial penalties or fines, or imprisonment. We believe that we are in material compliance with all applicable licensing laws and regulations.

We may become aware from time to time of certain states that require out-of-state laboratories to obtain licensure to accept specimens from patients within the state. If we identify any other state with such requirements, or if we are contacted by any other state advising us of such requirements, we intend to follow all instructions from the state regulators regarding compliance with such requirements.

International Laboratory Licensing

We also maintain laboratory operations in Germany and could expand our laboratory operations to other foreign jurisdictions.  Therefore, we are subject to laboratory quality regulations and accreditation standards in Germany, and will be subject to such regulations and standards in any other jurisdictions where we may operate.  These requirements may vary by jurisdiction and differ from those in the United States, and may require us to implement additional compliance measures.

In Vitro Diagnostics

In the future, we may elect to develop IVDs, which are regulated by the FDA as medical devices. Medical devices marketed in the United States are subject to the regulatory controls under CLIA, the Federal Food, Drug, and Cosmetic Act, and regulations adopted by the FDA. Some requirements, known as premarket requirements, apply to medical devices before they are marketed, and other requirements, known as post-market requirements, apply to medical devices after they are marketed.

The particular premarket requirements that must be met to market a medical device in the United States will depend on the classification of the device under FDA regulations. Medical devices are categorized into one of three classes, based on the degree of risk they present. Devices that pose the lowest risk are designated as Class I devices; devices that pose moderate risk are designated as Class II devices and are subject to general controls and special controls; and the devices that pose the highest risk are designated as Class III devices and are subject to general controls and premarket approval.

A premarket submission to the FDA will be required for some Class I devices, most Class II devices; and all Class III devices. Most Class I and some Class II devices are exempt from premarket submission requirements. Some Class I and most Class II devices may be marketed after a 510(k) premarket notification, while a more extensive PMA is required to market Class III devices.

Until regulatory requirements suggested by the FDA or required by any new legislation are phased in, our current LDTs will not require FDA filing before launch and we will continue to follow the CLIA certification and inspection pathway.

If the new requirements are phased in or if we elect to develop IVDs, our future screenings diagnostics may require a 510(k) submission or a Premarket Approval (“PMA”) application to the FDA. In a 510(k) submission, the device sponsor must demonstrate that the new device is “substantially equivalent” to a predicate device in terms of intended use, technological characteristics, and performance testing. A 510(k) requires demonstration of substantial equivalence to another device that is legally marketed in the United States. Substantial equivalence means that the new device is at least as safe and effective as the predicate. A device is substantially equivalent if, in comparison to a predicate it (a) has the same intended use as the predicate and has the same technological characteristics as the predicate; or (b) has the same intended use as the predicate, has different technological characteristics, and the information submitted to the FDA does not raise new questions of safety and effectiveness, and is demonstrated to be at least as safe and effective as the legally marketed predicate device.

A claim of substantial equivalence does not mean the new and predicate devices must be identical. Substantial equivalence is established with respect to intended use, design, energy used or delivered, materials, chemical composition, manufacturing process, performance, safety, effectiveness, labeling, biocompatibility, standards, and other characteristics. A device may not be marketed in the United States until the submitter receives a letter declaring the device substantially equivalent. If the FDA determines that a device is not substantially equivalent, the applicant may resubmit another 510(k) with new data, or request a Class I or II designation through the FDA’s de novo process that allows a new device without a valid predicate to be classified into Class I or II if it meets certain criteria, or file a reclassification petition, or submit a PMA.

A new 510(k) submission is required for changes or modifications to an existing approved device, where the modifications could significantly affect the safety or effectiveness of the device or the device is to be marketed for a new or different indication for use.

A PMA for Class III devices is the most stringent type of premarket submission. Before the FDA approves a PMA, the sponsor must provide valid scientific evidence demonstrating reasonable assurance of safety and effectiveness for the device’s intended use.

Health Insurance Portability and Accountability Act and Other Data Privacy and Security Laws

Under the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, also called HITECH, HHS has issued regulations to protect the privacy and security of protected health information (“PHI”) and to address breach notification requirements. HIPAA also regulates standardization of data content, codes and formats used in health care transactions and standardization of identifiers for health plans and providers. Penalties for violations of HIPAA regulations include civil and criminal penalties.

The HIPAA privacy regulations cover the use and disclosure of PHI by covered entities as well as business associates, which are persons or entities that perform certain functions for or on behalf of a covered entity that involve the creation, receipt, maintenance, or transmittal of PHI. Business associates are defined to include a subcontractor to whom a business associate delegates a function, activity, or service, other than in the capacity of the business associate’s workforce. As a general rule, a covered entity or business associate may not use or disclose PHI except as permitted or required under the privacy regulations. The privacy regulations also set forth certain rights that an individual has with respect to his or her PHI, including rights to access or amend certain records, to request restrictions on the use or disclosure of PHI, or to request an accounting of disclosures of his or her PHI.

Covered entities and business associates must also comply with HIPAA’s security regulations, which establish minimum requirements for safeguarding the confidentiality, integrity, and availability of PHI that is electronically transmitted or electronically stored. In addition, HITECH established, among other things, certain breach notification requirements with which covered entities and business associates must comply. In particular, a covered entity must notify any individual whose unsecured PHI is breached according to the specifications set forth in the breach notification rule. A covered entity must also notify the Secretary of the U.S. Department of Health and Human Services and, under certain circumstances, the media of a breach of unsecured PHI.

CMS and the Office of Civil Rights issued a final rule in February 2014 to amend both the HIPAA and CLIA regulations. The final rule amended the HIPAA privacy rule to remove the CLIA laboratory exceptions, and as a result, HIPAA-covered laboratories are now required to provide individuals, upon request, with access to their completed test reports. Under the 2014 rule, CLIA laboratories and CLIA-exempt laboratories may provide copies of a patient’s completed test reports that, using the laboratory’s authentication process, can be identified as belonging to that patient. These changes to the CLIA regulations and the HIPAA Privacy Rule were intended to provide individuals with a greater ability to access their health information. CLIA laboratories must create and maintain policies, procedures, and other documentation necessary to inform patients of the right to access laboratory test reports and how to exercise that right. In December 2020, aiming to remove regulations that impede communication and data exchange between providers and health plans and expand individuals’ rights to access their own digital health information, HHS proposed further changes to the HIPAA privacy rule. These most recently proposed updates of the HIPAA privacy rule are subject to public comment period until May 6, 2021.

The HIPAA privacy, security, and breach notification 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 or insofar as such state laws apply to personal information that is broader in scope than PHI as defined under HIPAA. Thus, in addition to the federal privacy regulations, there are a number of state laws regarding the privacy and security of health information and personal data that are applicable to clinical laboratories, and more states are considering these laws. The compliance requirements of these laws, including additional breach reporting requirements, and the penalties for violation vary widely and new privacy and security laws in this area are evolving. For example, California has implemented comprehensive privacy laws and regulations. The California Confidentiality of Medical Information Act imposes restrictive requirements regulating the use and disclosure of health information and other personally identifiable information. In addition to fines and penalties imposed upon violators, some of these state laws also afford private rights of action to individuals who believe their personal information has been misused. California’s patient privacy laws, for example, provide for penalties of up to $250,000 and permit injured parties to sue for damages. In addition to the California Confidentiality of Medical Information Act, California also recently enacted the California Consumer Privacy Act of 2018, or CCPA, which became effective January 1, 2020. The CCPA establishes a comprehensive privacy framework for covered businesses in the State of California, by creating an expanded definition of personal information, establishing new data privacy rights for consumers imposing special rules on the collection of consumer data from minors, and creating a new and potentially severe statutory damages framework for violations of the CCPA and for businesses that fail to implement reasonable security procedures and practices to prevent data breaches. While data subject to HIPAA and federal regulations governing the conduct of clinical trials is exempt from CCPA, certain of our business activities may be subject to CCPA. The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that result from a business’ failure to implement and maintain reasonable data security procedures.

State laws regarding the privacy and security of personal information are also evolving. For example, on November 3, 2020, California passed the California Privacy Rights Act (“CPRA”) through a ballot initiative. The CPRA will create a new California Privacy Protection Agency, an “independent watchdog” whose mission is both to “vigorously enforce” the CPRA and “ensure that businesses and consumers are well-informed about their rights and obligations.” Among other things, the CPRA will create a new category of “sensitive personal information” and offer consumers the right to limit processing of such information, impose purpose limitation, data minimization, data retention, and security compliance obligations on regulated businesses, and add or modify the rights available to consumers, including by providing a right to correct the information a business holds about them. The CPRA’s amendments to the CCPA will take effect on January 1, 2023, and will generally apply to personal information collected by businesses on or after January 1, 2022. Similarly, Colorado and Virginia have also passed comprehensive state privacy laws that are set to go into effect in 2023. In addition, every U.S. state has a data breach notification law that requires entities to report certain security breaches to affected consumers and, in some instances, state regulators and consumer reporting agencies. Failure to comply with applicable state laws that impose privacy, security, or breach notification requirements could result in significant civil or criminal penalties, administrative actions, or private causes of action by individuals, and adversely affect our business, results of operations and reputation.

Similar health care and data privacy laws and regulations exist in Europe and other jurisdictions, including reporting requirements detailing interactions with and payments to healthcare providers and requirements regarding the collection, distribution, use, security, and storage of personally identifiable information and other data relating to individuals, including the GDPR, which went into effect in May 2018. The GDPR applies to any company established in the EEA, as well as to those outside the EEA, if they collect and use personal data in connection with the offering of goods or services to individuals in the EEA or the monitoring of their behavior. Companies that must comply with the GDPR face increased compliance obligations and risk, including more robust regulatory enforcement of data protection requirements and potential fines for noncompliance of up to €20 million or 4% of the annual global revenues of the noncompliant company, whichever is greater. The GDPR provides that EU and EEA member states may introduce further conditions, including limitations, to the processing of genetic, biometric or health data, which could limit our ability to collect, use and share personal data, or could cause our compliance costs to increase, ultimately having an adverse impact on our business. Among other requirements, the GDPR regulates transfers of personal data subject to the GDPR to third countries that have not been found to provide adequate protection to such personal data, including the United States, and the efficacy and longevity of current transfer mechanisms between the European Union, or EU, and the United States remains uncertain. For example, in 2016, the EU and United States agreed to a transfer framework for data transferred from the EU to the United States, called the Privacy Shield, but the Privacy Shield was invalidated in July 2020 by the Court of Justice of the European Union.

Further, from January 1, 2021, companies have to comply with the GDPR and also the UK GDPR, which, together with the amended UK Data Protection Act 2018, retains the GDPR in UK national law. The UK GDPR mirrors the fines under the GDPR, e.g. fines up to the greater of €20 million (£17.5 million) or 4% of global turnover. On June 6, 2021, the European Commission implemented an adequacy decision enabling data transfers from EU member states to the United Kingdom without additional security measures. However, this adequacy decision includes a so-called “sunset-clause” stipulating that it will expire after four (4) years, and providing that the Commission will monitor the UK’s legal situation and could intervene at any point if it determines the UK has deviated from the level of protections in place at the time of the decision. The revocation or expiration of the Commission’s adequacy decision for the UK could require additional measures to ensure adequate protection and GDPR compliance and may lead to additional costs and increases our overall risk exposure.

Physician Referral Prohibitions

Under a federal law directed at “self-referral,” commonly known as the Stark Law, there are prohibitions, with certain exceptions, on Medicare and Medicaid payments for laboratory tests referred by physicians who personally, or through a family member, have a “financial relationship”—including an investment or ownership interest or a compensation arrangement—with the clinical laboratory performing the tests. Several Stark Law exceptions are relevant to arrangements involving clinical laboratories, including: (1) fair market value compensation for the provision of items or services; (2) payments by physicians to a laboratory for clinical laboratory services; (3) certain space and equipment rental arrangements that satisfy certain requirements, and (4) personal services arrangements that satisfy certain requirements. The laboratory cannot submit claims to the Medicare Part B program for services furnished in violation of the Stark Law, and Medicaid reimbursements may be at risk as well. Penalties for violating the Stark Law include the return of funds received for all prohibited referrals, fines, civil monetary penalties and possible exclusion from the federal health care programs. Many states have comparable laws that are not limited to Medicare and Medicaid referrals.

On November 20, 2020, CMS issued a final rule to modernize and clarify the regulations that interpret self-referral law. The final rule was issued in conjunction with the CMS Patients over Paperwork initiative and the HHS Regulatory Sprint to Coordinated Care and establishes exceptions to the physician self-referral law for certain value-based compensation arrangements between or among physicians, providers, and suppliers. It also establishes a new exception for certain arrangements under which a physician receives limited remuneration for items or services actually provided by the physician; establishes a new exception for donations of cybersecurity technology and related services; and amends the existing exception for electronic health records (EHR) items and services. While the final rule presents significant opportunities for new arrangements, it also necessitates revisions to current arrangements involving healthcare providers, others involved in the healthcare industry, and patients.

Corporate Practice of Medicine

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 us 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 we are engaged in the unauthorized corporate practice of medicine, we could be required to restructure our contractual and other arrangements. In addition, violation of these laws may result in sanctions imposed against us and/or the professional through licensure proceedings, and we could be subject to civil and criminal penalties that could result in exclusion from state and federal health care programs.

Federal and State Fraud and Abuse Laws

A variety of federal and state laws prohibit fraud and abuse. These laws are interpreted broadly and enforced aggressively by various state and federal agencies, including CMS, the Department of Justice, the Office of Inspector General for HHS, and various state agencies. In addition, the Medicare and Medicaid programs increasingly use a variety of contractors to review claims data and to identify improper payments as well as fraud and abuse. These contractors include Recovery Audit Contractors, Medicaid Integrity Contractors and Zone Program Integrity Contractors. In addition, CMS conducts Comprehensive Error Rate Testing audits, the purpose of which is to detect improper Medicare payments. Any overpayments identified must be repaid unless a favorable decision is obtained on appeal. In some cases, these overpayments can be used as the basis for an extrapolation, by which the error rate is applied to a larger universe of claims, and which can result in even higher repayments.

The federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, to induce or in return for either the referral of an individual, or the furnishing, recommending, or arranging for the purchase, lease or order of any health care item or service reimbursable, in whole or in part, under a federal health care program. The definition of “remuneration” has been broadly interpreted to include anything of value, including gifts, discounts, credit arrangements, payments of cash, ownership interests and providing anything at less than its fair market value. Recognizing that the Anti- Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements within the health care industry, the Office of Inspector General for HHS has issued a series of regulatory “safe harbors.” These safe harbor regulations set forth certain requirements that, if met, will assure immunity from prosecution under the federal Anti-Kickback Statute. Although full compliance with these provisions ensures against prosecution under the federal Anti-Kickback Statute, the failure of a transaction or arrangement to fit within a specific safe harbor does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the federal Anti-Kickback Statute will be pursued.

Federal civil and criminal false claims laws, including the False Claims Act, prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government or knowingly making, or causing to be made, a false statement to get a false claim paid. Violations of the False Claims Act can result in very significant monetary penalties and treble damages. Over the past few years, several healthcare companies have been prosecuted under these laws for a variety of alleged promotional and marketing activities, including without limitation, allegedly providing free trips, free goods, sham consulting fees and grants and other monetary benefits to prescribers. In addition, the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal False Claims Act. Most states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor.

Federal civil monetary penalties laws impose civil fines for, among other things, the offering or transfer of remuneration to a Medicare or state healthcare program beneficiary if the person knows or should know it is likely to influence the beneficiary’s selection of a particular provider, practitioner, or supplier of services reimbursable by Medicare or a state healthcare program, unless an exception applies.

The Eliminating Kickbacks in Recovery Act (“EKRA”) specifically targets laboratories, clinics, recovery centers, and other clinical treatment centers from accepting or paying kickbacks for referrals. EKRA is broader than the federal Anti-Kickback Statute because it applies to private health insurance plans in addition to the federal health care programs, and it prohibits arrangements that may otherwise be exempt from liability under the Anti-Kickback Statute’s safe harbors, including certain compensation arrangements with laboratory sales and marketing personnel.

HIPAA also created new federal crimes, including health care fraud and false statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including private third-party payers. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from federal health care programs, such as the Medicare and Medicaid programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for health care benefits, items or services. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from federal health care programs.

Many states have laws similar to the federal laws described above, and state laws may be broader in scope and may apply regardless of payer.

Additionally, the U.S. Foreign Corrupt Practices Act (“FCPA”) prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations.

Other Regulatory Requirements

Our laboratory will be subject to federal, state and local regulations relating to the handling and disposal of regulated medical waste, hazardous waste and biohazardous waste, including chemical, biological agents and compounds, blood samples and other human tissue. Typically, we will use outside vendors who are contractually obligated to comply with applicable laws and regulations to dispose of such waste. These vendors will be licensed or otherwise qualified to handle and dispose of such waste.

The Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for health care employers, including requirements to develop and implement programs to protect workers from exposure to blood-borne pathogens by preventing or minimizing any exposure through needle stick or similar penetrating injuries.

On May 1, 2020, the Office of the National Coordinator for Health Information Technology promulgated final regulations under the authority of the 21st Century Cures Act that impose new conditions to obtain and maintain certification of certified health information technology and prohibit certain covered actors, including operators of laboratories which are considered “health care providers” under the final regulation, from engaging in activities that are likely to interfere with the access, exchange, or use of electronic health information (information blocking). The final regulations further defined exceptions for activities that are permissible, even though they may have the effect of interfering with the access, exchange, or use of electronic health information. The information blocking effective date is April 5, 2021. Under the 21st Century Cures Act, health care providers that violate the information blocking prohibition will be subject to appropriate disincentives, which HHS services has yet to establish through required rulemaking. Developers of certified information technology and health information networks and health information exchanges, however, may be subject to civil monetary penalties of up to $1 million per violation. The HHS Office of Inspector General has the authority to impose such penalties and on April 24, 2020 published a proposed rule to codify its new authority in regulation, which the agency proposed would become effective 60 days after it issues a final rule, but in no event before November 2, 2020. HHS Office of Inspector General has not yet issued a final rule.

Employees

As of December 31, 2021, we employed 110 persons on a full-time basis and five persons on a part-time basis.