Rennova Health, Inc. (together with
its subsidiaries, “Rennova”, “we” or the “Company”) is a provider of an expanding group
of health care services for healthcare providers, their patients and individuals. Historically, we have operated our business
under one management team, but beginning in 2017, the Company intends to operate in four synergistic divisions
with specialized management: 1) Clinical diagnostics through its clinical laboratories; 2) supportive software solutions to healthcare
providers including Electronic Health Records (“EHR”), Laboratory Information Systems and Medical Billing
services; 3) Decision support and interpretation of cancer and genomic diagnostics; and 4) the recent addition of a hospital
in Tennessee. We believe that our approach will produce a more sustainable relationship and the capture of multiple revenue
streams from medical providers.
Historically, we have specialized in providing urine and blood
drug toxicology and pain medication testing to physicians, clinics and rehabilitation facilities in the United States. We intend
to expand our business operations in each sector in which we focus and will continue to assess the best way to do so. We may consider
the sale of or spin-off of one or more of our business operations if deemed to be the best way to create value for our shareholders.
History and Development of the Company
Medytox Solutions, Inc. (“Medytox”)
was organized on July 20, 2005 under the laws of the State of Nevada. In the first half of 2011, Medytox’s management elected
to reorganize as a holding company, and Medytox established and acquired a number of companies in the medical service sector between
2011 and 2014.
On November 2, 2015, pursuant to the terms
of the Agreement and Plan of Merger, dated as of April 15, 2015, by and among CollabRx, Inc. (“CollabRx”), CollabRx
Merger Sub, Inc. (“Merger Sub”), a direct wholly-owned subsidiary of CollabRx formed for the purpose of the merger,
and Medytox, Merger Sub merged with and into Medytox, with Medytox as the surviving company and a direct, wholly-owned subsidiary
of CollabRx (the “Merger”). Prior to closing, the Company amended its certificate of incorporation to effect a 1-for-10
reverse stock split and to change its name to Rennova Health, Inc. In connection with the Merger, (i) each share of common stock
of Medytox was converted into the right to receive 0.4096 shares of common stock of the Company, (ii) each share of Series B Preferred
Stock of Medytox was converted into the right to receive one share of a newly-authorized Series B Convertible Preferred Stock of
the Company, and (iii) each share of Series E Convertible Preferred Stock of Medytox was converted into the right to receive one
share of a newly-authorized Series E Convertible Preferred Stock of the Company. This transaction was accounted for as a reverse
merger in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and,
as such, the historical financial statements of Medytox became the historical financial statements of the Company.
Holders of Company equity prior to the closing
of the Merger (including all outstanding Company common stock and all restricted stock units, options and warrants exercisable
for shares of Company common stock) held 10% of the Company’s common stock immediately following the closing of the Merger,
and holders of Medytox equity prior to the closing of the Merger (including all outstanding Medytox common stock and all outstanding
options exercisable for shares of Medytox common stock, but less certain options that were cancelled upon the closing pursuant
to agreements between Medytox and such optionees) held 90% of the Company’s common stock immediately following the closing
of the Merger, in each case on a fully diluted basis, provided, however, outstanding shares of the newly-designated Series B Convertible
Preferred Stock and Series E Convertible Preferred Stock, certain outstanding convertible promissory notes exercisable for Company
common stock after the closing and certain option grants expected to be made following the closing of the Merger are excluded from
such ownership percentages.
On November 3, 2015, the common stock of Rennova
Health, Inc. commenced trading on The NASDAQ Capital Market under the symbol “RNVA.” Prior to that date, our common
stock was listed on The NASDAQ Capital Market under the symbol “CLRX.” Immediately after the consummation of the Merger,
the Company had 13,750,010 shares of common stock, 5,000 shares of Series B Convertible Preferred Stock and 45,000 shares of Series
E Convertible Preferred Stock issued and outstanding.
Recent Developments
On April 9, 2017,
Robert Lee and Dr. Paul Billings resigned from our Board of Directors. Mr. Lee and Dr. Billings were the two independent
directors and were members of the Audit, Compensation and Nominating/Corporate Governance Committees of the Board. On April
9, 2017, the remaining members of the Board elected Trevor Langley and Dr. Kamran Ajami as directors to fill those
two Board vacancies. The Board of Directors
determined that both of the new directors qualify as “independent” under the Listing Rules of The NASDAQ Stock
Market and the rules and regulations of the Securities and Exchange Commission.
Trevor Langley, 55, since 1997 has been
the Owner and Managing Partner of Avanti Capital Group LLC/Avanti Partners LLC (“Avanti”). Avanti assists micro, small
and mid-cap publicly traded companies and those looking to become public by leveraging traditional and new communication strategies,
with a specialization in healthcare and alternative energy markets. Avanti also provides comprehensive consulting services.
Dr. Kamran Ajami, 58, is a
pathologist and, since February 2011, has been the Medical Director of the laboratories at West Side Regional Medical Center
and Plantation General Hospital. Since 1997, he has also been Owner and Chief Executive Officer of American
Cytopathology Associates PA, which supplies medical directors for laboratories.
The Board named Mr. Langley and Dr. Ajami as members of the Audit Committee, with Mr. Langley as Chairman. In addition to each
of them being “independent”, the Board of Directors determined that each of them is “financially literate”
as required by the Listing Rules of The NASDAQ Stock Market and that Mr. Langley qualifies as an “audit committee financial
expert” as defined by the rules and regulations of the SEC and meets the qualifications of “financial sophistication”
under the Listing Rules of The NASDAQ Stock Market. The Board named Mr. Langley and Dr. Ajami also as members
of the Compensation Committee (with Mr. Langley as Chairman) and of the Nominating/Corporate Governance Committee (with Dr.
Ajami as Chairman).
On March 21, 2017, we closed an offering of
$10,850,000 principal amount of Senior Secured Original Issue Discount Convertible Debentures due March 21, 2019 (the “New
Debentures”) and three series of warrants to purchase an aggregate of 19,608,426 shares of common stock, as further described
below (each a “Warrant” and, collectively, the “Warrants”). The offering was pursuant to the terms of the
Securities Purchase Agreement, dated as of March 15, 2017 (the “Purchase Agreement”), between the Company and certain
existing institutional investors of the Company. The Company received proceeds of approximately $8.4 million from the offering,
after giving effect to the original issue discounts and transaction expenses. The net proceeds were used to pay down certain related
party and other indebtedness (see “Liquidity and Corporate Reserves”) and for general corporate purposes.
Also on March 21, 2017, we
closed an exchange by which the holders of the Company’s Original Issue Discount Convertible Debentures issued on February
2, 2017 and holders of the Company’s Series H Convertible Preferred Stock exchanged $1,590,000 principal amount of such debentures
and $2,174,000 stated value of such preferred stock for $5,160,260 principal amount of new debentures on the same items as, and
pari passu with, the New Debentures (the “Exchange Debentures” and, together with the New Debentures, the “Debentures”)
and Warrants to purchase an aggregate of 9,325,773 shares of common stock. All issuance amounts of Debentures reflect a 24% original
issue discount.
The Debentures are convertible
at any time at an initial conversion price of $1.66. The New Debentures begin to amortize monthly commencing on the 90th day following
March 21, 2017 and the Exchange Debentures begin to amortize monthly immediately. On each monthly amortization date, the Company
may elect to repay 5% of the original principal amount of Debentures in cash or, in lieu thereof, the conversion price of such
Debentures shall thereafter be 85% of the volume weighted average price at the time of conversion. In the event the Company does
not elect to pay such amortization amounts in cash, each investor, in their sole discretion, may increase the conversion amount
subject to the alternative conversion price by up to four times the amortization amount. The Debentures contain customary affirmative
and negative covenants. The conversion price is subject to reset in the event of offerings or other issuances of common stock,
or rights to purchase common stock, at a price below the then conversion price, as well as other customary antidilution protections.
The Series A Warrants are
exercisable for up to a number of shares of Common Stock equal to 100% of the shares underlying the Debentures, or an aggregate
of 9,644,736 shares. They are immediately exercisable and have a term of exercise equal to five years. The Series B Warrants are
exercisable for up to a number of shares of Common Stock equal to 100% of the shares underlying the Debentures, or an aggregate
of 9,644,736 shares, and are exercisable for a period of 18 months commencing immediately. The Series C Warrants are exercisable
for up to a number of shares of Common Stock equal to 100% of the shares underlying the Debentures, or an aggregate of 9,644,736
shares, and have a term of five years provided such Warrants shall only vest if, when and to the extent that the holders exercise
the Series B Warrants. The Series A and Series C Warrants each have an exercise price of $1.95 and the Series B Warrants have an
exercise price of $1.66. The exercise price of all Warrants is subject to reset in the event of offerings or other issuances of
common stock, or rights to purchase common stock, at a price below the then exercise price, as well as other customary anti-dilution
protections.
Holders of Debentures and
Warrants are prohibited from converting or exercising such Debentures or Warrants into or for Common Stock if, as a result of such
conversion or exercise, the holder, together with its affiliates, would own more than 4.99% of the total number of shares of Common
Stock then issued and outstanding. However, any holder may increase or decrease such percentage to any other percentage not in
excess of 9.99%, provided that any increase in such percentage shall not be effective until 61 days after notice to the Company.
The Company is obligated
to file a registration statement registering for resale the shares underlying the Debentures and Warrants on or before April 7,
2017 and use best efforts to cause such registration statement to be declared effective within 45 days or 75 days if reviewed.
Additionally, the Company is required to seek stockholder approval to issue in excess of 20% of the issued and outstanding shares
of Common Stock. The holders were also granted a right of participation in up to 50% of any future offerings for so long as the
Debentures and Warrants are outstanding.
On February 7, 2017, our Board of Directors
approved an amendment to the Company’s Certificate of Incorporation to effect a 1-for-30 reverse stock split of the Company’s
shares of common stock effective on February 22, 2017 (the “Reverse Stock Split”). The stockholders of the Company
had previously approved, on December 22, 2016, an amendment to the Company’s Certificate of Incorporation to effect a reverse
split of all of the Company’s shares of common stock at a specific ratio within a range from 1-for-10 to 1-for-30, and granted
authorization to the Board of Directors to determine in its discretion the specific ratio and timing of the reverse split prior
to December 31, 2017.
As a result of the Reverse Stock Split, every
30 shares of the Company’s then outstanding common stock was combined and reclassified into one share of the Company’s
common stock. Proportionate voting rights and other rights of common stockholders were not affected by the Reverse Stock Split,
other than as a result of the rounding up of fractional shares. Stockholders who would have otherwise held a fractional share of
common stock had their holdings rounded up to the nearest full share, as no fractional shares were issued in connection with the
Reverse Stock Split.
The reverse stock split became effective at
the close of business on February 22, 2017 and our common stock began trading on the NASDAQ Capital Market on a post-split basis
on February 23, 2017. The par value and other terms of the common stock were not affected by the Reverse Stock Split. The authorized
capital of the Company of 500,000,000 shares of common stock and 5,000,000 shares of preferred stock were also unaffected by the
Reverse Stock Split. All outstanding preferred shares, stock options, warrants, convertible notes and equity incentive plans immediately
prior to the Reverse Stock Split were adjusted by dividing the number of shares of common stock into which the preferred shares,
stock options, warrants, notes and equity incentive plans of the common stock were exercisable or convertible by 30 and multiplying
the exercise or conversion price by 30. All share and per share amounts discussed in this Annual Report on Form 10-K have been
retroactively restated to give effect to the Reverse Stock Split.
On January 13, 2017, we closed on an asset
purchase agreement to acquire certain assets related to Scott County Community Hospital, based in Oneida, Tennessee (the “Hospital
Assets”). The Hospital Assets include a 52,000 square foot hospital building and 6,300 square foot professional building
on approximately 4.3 acres. Scott County Community Hospital is classified as a Critical Access Hospital (rural) with 25 beds, a
24/7 emergency department, operating rooms and a laboratory that provides a range of diagnostic services. Scott County Community
Hospital closed in July 2016 in connection with the bankruptcy filing of its parent company, Pioneer Health Services, Inc. We acquired
the Hospital Assets out of bankruptcy for a purchase price of $1.0 million. We expect to have the hospital open in part in the
second quarter of 2017, and that the hospital will be fully operational by the third quarter of 2017, in each case, subject to
the receipt of the necessary licenses and regulatory approvals.
On January 11, 2017, we were notified by Nasdaq
that we no longer comply with Nasdaq's audit committee requirements as set forth in Nasdaq Listing Rule 5605 (the "Rule"),
which requires the audit committee of the Company's Board of Directors to have at least three members, each of whom must be independent
directors as defined under the Rule. With the passing of one of our directors, Benjamin Frank, in December of 2016, our audit committee
currently consists of two independent directors. In accordance with Nasdaq Rule 5605(c)(4), we have until the earlier of our next
annual shareholders' meeting or December 18, 2017 to regain compliance; or, if our next annual shareholders' meeting is held before
June 16, 2017, then we must evidence compliance no later than June 16, 2017. If we do not regain compliance by the foregoing applicable
dates, then Nasdaq will provide written notification to us that our securities will be delisted.
Our Services
We are a healthcare enterprise that delivers products and
services to healthcare providers, their patients and individuals. Historically, we have operated our business under one
management team, but beginning in 2017, we intend to operate in four synergistic divisions with specialized management: 1) Clinical
diagnostics through our clinical laboratories; 2) supportive software solutions to healthcare providers including
Electronic Health Records (“EHR”), Laboratory Information Systems and Medical Billing services; 3) Decision
support and interpretation of cancer and genomic diagnostics; and 4) the recent addition of a hospital in Tennessee. We
aspire to create a more sustainable relationship with our customers by offering needed and interoperable solutions to capture
multiple revenue streams from medical providers.
Clinical Diagnostics
Our principal line of business over the past
few years has been clinical laboratory blood and urine testing services, with a particular emphasis on the provision of urine drug
toxicology testing to physicians, clinics and rehabilitation facilities in the United States. As we expand our customer base to
include pain management and other healthcare providers, testing services to rehabilitation facilities represented approximately
75% of the Company’s revenues for the year ended December 31, 2016 and approximately 95% of the Company’s revenues
for the years ended December 31, 2015 and 2014. We believe that we are responding to the challenges faced by today’s healthcare
providers to adopt paper free and interoperable systems, and to market demand for solutions by strategically expanding our offering
of diagnostics services to include a full suite of clinical laboratory services. The drug and alcohol rehabilitation and pain management
sectors provide an existing and sizable target market, where the need for our services already exists and opportunity is being
created by a continued secular growth and need for compliance.
In 2016 we added genetic testing, specifically
pharmacogenetic testing, to our array of services. Genetic testing represents the most rapidly expanding segment of the diagnostics
market worldwide. Growing incidence of genetic diseases presents new opportunities for genetic testing. According to a report issued
by Global Industry Analysts, Inc., the global market for genetic testing is forecast to reach $2.2 billion by 2017. Increasing
knowledge about the potential benefits of genetic testing is one of the prime reasons for the growth of the market. Advancements
in the genetic testing space, an aging population and a corresponding rise in the number of chronic diseases, and increasing incidence
of cancer cases are other factors propelling growth in the genetic testing market.
Primary revenue generating activity in this
market revolves around DNA profiling aimed at better understanding the predisposition for diseases and possible adverse reactions
that may occur with drugs that are currently available and/or under clinical development. Rising importance of early infection
detection and prevention together with growing demand of DNA tests in pharmacogenomics or cancer genetic testing are significant
factors responsible for the anticipated growth. In order to further capitalize on this opportunity, we have entered into an agreement
to acquire the remaining outstanding equity interests of Genomas, Inc., a biomedical company that develops PhyzioType Systems for
DNA-guided management and prescription of drugs used to treat mental illness, pain, heart disease and diabetes.
The Company owns and operates the following
products and services to support its business objectives and to enable it to offer these services to its customers:
Medytox Diagnostics, Inc. (“MDI”)
Through our CLIA certified laboratories, Rennova
offers toxicology, clinical pharmacogenetics and esoteric testing. Rennova seeks to provide these testing services with superior
logistics and specimen integrity, competitive turn-around times and excellent customer service.
Clinical Laboratory Operations
The Company, through its wholly-owned MDI subsidiary,
owns four clinical laboratories, as follows:
|
Laboratory
|
Location
|
|
Alethea Laboratories, Inc.
|
Las Cruces, NM
|
|
International Technologies, LLC
|
Waldwick, NJ
|
|
EPIC Reference Labs, Inc.
|
Riviera Beach, FL
|
|
Epinex Diagnostics Laboratories, Inc.
|
Tustin, CA
|
During the year ended December 31, 2016, the
Company experienced a substantial decline in the volume of samples processed at its laboratories and continued difficulty in receiving
reimbursement for certain diagnostics. As result, in an effort to reduce costs, the Company is currently operating all of its Clinical
Laboratory Operations business segment out of its EPIC Reference Labs, Inc. (“EPIC”) laboratory, and cost reduction
efforts are continuing in response to the operating losses incurred in 2016. MDI formed EPIC as a wholly-owned subsidiary on January
29, 2013 to provide reference, confirmation and clinical testing services. The Company acquired necessary equipment and licenses
in order to allow EPIC to test urine for drugs and medication monitoring. Operations at EPIC began in January 2014 using approximately
2,500 square feet and the premises has since been expanded to occupy approximately 12,500 square feet.
Epinex Diagnostics has initiated a relationship
and integration with a California-based Clinical Research Organization that the Company believes will see it providing testing
services to this Clinical Research Organization starting in the second quarter of 2017. Alethea Laboratories operates in a State
that permits direct to consumer testing but remains subject to certain regulations governing the patient in the State from which
they might order a diagnostic.
The Company’s Medytox Medical Marketing
& Sales, Inc. (“MMMS”) subsidiary was formed on March 9, 2013 as a wholly-owned subsidiary to provide marketing,
sales, and customer service exclusively for our clinical laboratories.
Supportive Software Solutions
Advantage software
Advantage is a proprietary HIPAA compliant software developed to
eliminate the need for paper requisitions by providing an easy to use and efficient web-based system that lets customers securely
place lab orders, track samples and view test reports in real time from any web-enabled laptop, notepad or smart phone.
Clinlab
ClinLab
is a Windows-based web-enabled laboratory information management system. It acts as a HIPAA-compliant data warehouse for lab results
and includes reporting, data acquisition, label printing, electronic signoff and numerous interface capabilities to a multitude
of reference labs and practice systems
that scales from small physician-operated labs to large clinical reference laboratories.
Medical Mime
Medical
Mime’s suite of solutions includes a uniquely optimized EHR for substance abuse and behavioral health providers, a dictation-based
ambulatory EHR for physician practices, and advanced transcription services. Solutions are web-based, 100% secure, and HIPAA compliant,
with remote access, on-site training and intensive 24/7 technical support
.
The Company has four operating subsidiaries
that provide supportive services, historically primarily to its clinical laboratories and corporate operations and to a lesser
but now increasing extent, third party customers.
Medical Billing Choices, Inc. (“MBC”)
:
MBC was acquired by the Company on August 22, 2011 in an agreement that closed in July 2013. MBC provides revenue cycle management
services to third party customers, with an initial focus on substance abuse facilities, by utilizing tools designed to improve
documentation and collect information, driving faster reimbursement with fewer denied claims. MBC also functions as our in-house
billing company which compiles and sends invoices to our Clinical Laboratory Operations customers (primarily insurance companies,
Medicaid, Medicare, and Preferred Provider Organizations (“PPOs”)) for reimbursement.
Health Technology Solutions, Inc. (“HTS”)
:
HTS is a wholly-owned subsidiary that provides information technology and software solutions including continued development of
software to our subsidiaries and outside medical service providers. This entity provides the set up services for customers and
supports our clinical labs and other operations.
ClinLab, Inc. (“ClinLab”):
ClinLab was acquired by the Company on March 18, 2014. ClinLab develops and markets laboratory information management systems (“LIS”).
ClinLab has installed its LIS into the Company’s laboratories to create a uniform LIS platform throughout the Company’s
laboratories.
Medical Mime, Inc. (“Mime”):
Mime was formed on May 9, 2014 as a wholly-owned subsidiary that specializes in EHR, initially targeting the rehab marketplace.
We launched an enhanced version of our EHR software in the second quarter of 2016, which includes Electronic Medication Administration
Records (“eMAR”). Our eMAR enhancement allows physicians to transition additional processes from paper to our software
platform. eMAR automates the gathering, consolidating and presenting of data with more speed and accuracy than any manual system.
Decision Support Interpretation of Cancer
and Genomic Diagnostics
We
own a solution in CollabRx to provide evidence, interpretation and therapy guidance to enhance genomic testing and to provide actionable
decision support for standardized, evidence-based cancer care and superior clinical outcomes in precision oncology.
We also
operate a biomedical company, Genomas, Inc. (“Genomas”), bringing DNA-Guided medicine to clinical practice with products
for personalized prescription of drugs used in the treatment of mental illness, diabetes, and cardiovascular disease (“CVD”).
Our products eliminate trial-and-error prescription with DNA-Guided medicine and enable physicians to treat with unprecedented
precision, avoiding significant drug side effects, improving efficacy and enhancing patient compliance. Core applications are drug
treatments of mood and thought disorders in mental illness and of cardiometabolic risk in diabetes and CVD.
CollabRx was acquired by the Company on November 2, 2015 via the
Merger as discussed above. CollabRx develops and markets medical information and clinical decision support products and services
intended to set a standard for the clinical interpretation of genomics-based, precision medicine. CollabRx offers interpretation
and decision support solutions that enhance cancer diagnoses and treatment through actionable data analytics and reporting for
oncologists and their patients.
We entered into an agreement to acquire Genomas
in late 2016. Genomas has developed PhyzioGenomics technology as a proprietary platform integrating genotypic and phenotypic measures
to correlate gene variability with physiological variability. Genomas has established a DNA repository and clinical registry of
6,000 patients with mental illness, diabetes and cardiovascular disease. The clinical data from these extensive cohorts is integrated
systematically into the PhyzioClinica Database. A PhyzioType System consists of three components: an array of inherited, stable
DNA polymorphisms from various genes to establish a patient’s combinatorial genotype, bioclinical algorithms for predicting
the patient’s drug response, and a portal for doctors to select the best drug for the patient.
Hospital
The Company believes that the acquisition or development of hospitals
will create a stable revenue base as a needed service and believes that it can expand the sales of its products and services to
surrounding medical providers and doctors’ groups.
On January 13, 2017, we acquired the Hospital
Assets, which include a 52,000 square foot hospital building and 6,300 square foot professional building on approximately 4.3 acres.
Scott County Community Hospital, since renamed Big South Fork Medical Center, is classified as a Critical Access Hospital (rural)
with 25 beds, a 24/7 emergency department, operating rooms and a laboratory that provides a range of diagnostic services. We expect
to have the hospital open in part in the second quarter of 2017, and that the hospital will be fully operational by the third quarter
of 2017, in each case, subject to the receipt of the necessary licenses and regulatory approvals.
The hospital had unaudited annual revenues
of approximately $12 million, and a normalized EBITDA of approximately $1.3 million for Fiscal 2015, the last full year of the
hospital's operation. These revenues were attributable to the typical services of a rural acute care hospital, including emergency
room visits, outpatient procedures, diagnostic ancillary tests, physical therapy and inpatient hospital stays. Based on the hospital's
historical information, we believe the hospital offers an established patient and stable revenue base as it serves the general
healthcare needs of its community and supports local physicians.
Marketing Strategy
Rennova provides a suite of products and services
to the medical services sector. We endeavor to be a single source for multiple business solutions that serve the medical services
industry. We have invested in a professional sales team, a client services team and proprietary technologies to better serve the
needs of the modern-day medical provider. The Company intends to expand, through its acquisition and subsequent integration of
businesses, into a robust business model providing an extensive range of services to medical providers that demonstrate improved
patient care and outcomes.
Competition
For our diagnostics division, the Company competes
in a fragmented industry split between independently-owned and physician-owned laboratories. There are three predominant players
in the industry that operate as full-service clinical laboratories (processing blood, urine and other tissue). In addition, the
competition ranges from smaller privately-owned laboratories (3-6 employees) to large publicly-traded laboratories with significant
market capitalizations.
For our software division the market for practice
management, EHR and revenue cycle management (“RCM”) information solutions and related services is highly competitive,
and we expect competition to increase in the future. We face competition from other providers of both integrated and stand-alone
practice management, EHR and RCM solutions, including competitors who utilize a web-based platform and providers of locally installed
software systems. Our competitors also include larger healthcare IT companies with longer operating histories, greater brand recognition
and greater financial, marketing and other resources than us. We also compete with various regional RCM companies, some of which
may continue to consolidate and expand into broader markets. We expect that competition will continue to increase as a result of
consolidation in both the information technology and healthcare industries.
For our decision support and interpretation
of cancer and genomic diagnostics sector, while we believe we have some distinguishing and unique features that create a competitive
advantage, we also recognize that the sector has attracted many larger companies that have greater financial strength and marketing
capabilities.
Governmental Regulation
General
The clinical laboratory industry is subject
to significant governmental laws and regulations at the federal, state and local levels. As described below, these laws and regulations
concern licensure and operation of clinical laboratories, claim submission and payment for laboratory services, health care fraud
and abuse, security, privacy and confidentiality of health information, quality and environmental and occupational safety.
Regulation of Clinical Laboratories
The Clinical
Laboratory Improvement Amendments (“CLIA”) are regulations that include federal standards applicable to all U.S. facilities
or sites that test human specimens for health assessment or to diagnose, prevent, or treat disease. The Centers for Disease Control
and Prevention (“CDC”), in partnership with the Centers for Medicare and Medicaid Services (“CMS”) and the
Food and Drug Administration (“FDA”), supports the CLIA program and clinical laboratory quality.
CLIA requires
that all clinical laboratories meet quality assurance, quality control and personnel standards. Laboratories also must undergo
proficiency testing and are subject to inspections.
Standards for testing under CLIA are based
on the complexity of the tests performed by the laboratory, with tests classified as “high complexity,” “moderate
complexity,” or “waived.” Laboratories performing high complexity testing are required to meet more stringent
requirements than moderate complexity laboratories. Laboratories performing only waived tests, which are tests determined by the
FDA to have a low potential for error and requiring little oversight, may apply for a certificate of waiver exempting them from
most of the requirements of CLIA. All Company facilities hold CLIA certificates to perform high complexity testing. The sanctions
for failure to comply with CLIA requirements include suspension, revocation or limitation of a laboratory's CLIA certificate, which
is necessary to conduct business, cancellation or suspension of the laboratory's approval to receive Medicare and/or Medicaid reimbursement,
as well as significant fines and/or criminal penalties. The loss or suspension of a CLIA certification, imposition of a fine or
other penalties, or future changes in the CLIA law or regulations (or interpretation of the law or regulations) could have a material
adverse effect on the Company.
In addition to compliance with the federal
regulations, the Company is also subject to state and local laboratory regulation. CLIA provides that a state may adopt laboratory
regulations different from or more stringent than those contained in Federal law. There are approximately 12 states with state
licensure or permit requirements for an independent lab facility physically located within the state. State laws may require that
laboratory personnel meet certain qualifications, specify certain quality controls, or require maintenance of certain records.
There are a number of states (including California and Florida) that have even more stringent requirements with which lab personnel
must comply to obtain state licensure or a certificate of qualification.
The Company believes that it is in compliance
with all applicable laboratory requirements. The Company's laboratories have continuing programs to ensure that their operations
meet all such regulatory requirements, but no assurances can be given that the Company's laboratories will pass all future licensure
or certification inspections. The Company has implemented the position of Chief Compliance Officer with supporting staff, including
staff specifically for licensing, credentialing and certification inspection purposes. We embrace compliance as an integral part
of our culture and we consistently promote that culture of ethics and integrity.
The FDA has regulatory responsibility
over instruments, test kits, reagents and other devices used by clinical laboratories. The FDA has issued draft guidance regarding
FDA regulation of laboratory-developed tests (“LDTs”), but if or how the draft guidance will be implemented is uncertain.
On November 18, 2016, the FDA announced it would not release final guidance at this time and instead would continue to work with
stakeholders, the new administration and Congress to determine the right approach, and on January 3, 2017, the FDA released a discussion
paper outlining a possible risk-based approach for FDA and CMS oversight of LTDs. There are many other regulatory and legislative
proposals that would increase general FDA oversight of clinical laboratories and LDTs. The outcome and ultimate impact of such
proposals on the business is difficult to predict at this time. Our point of collection testing devices are regulated by the FDA.
The FDA has authority to take various administrative and legal actions for non-compliance, such as fines, product suspension, warning
letters, injunctions and other civil and criminal sanctions. We make every good faith effort to exercise proactive monitoring and
review of pending legislation and regulatory action.
Payment for Clinical Laboratory Services
In each of 2016 and 2015, the Company derived
less than 10% of its net sales directly from the Medicare and Medicaid programs. In addition, the Company's other business depends
significantly on continued participation in these programs and in other government healthcare programs, in part because clients
often want a single laboratory to perform all of their testing services. In recent years, both governmental and private sector
payers have made efforts to contain or reduce health care costs, including reducing reimbursement for clinical laboratory services.
Reimbursement under the Medicare program for
clinical diagnostic laboratory services is subject to a clinical laboratory fee schedule that sets the maximum amount payable in
each Medicare carrier's jurisdiction. This clinical laboratory fee schedule is updated annually. Laboratories bill the program
directly for covered tests performed on behalf of Medicare beneficiaries. State Medicaid programs are prohibited from paying more
than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients.
Payment under the Medicare fee schedule has
been limited from year to year by Congressional action, including imposition of national limitation amounts and freezes on the
otherwise applicable annual Consumer Price Index (“CPI”) updates. For most diagnostic lab tests, the national limitation
is now 74.0% of the national median of all local fee schedules established for each test. Under a provision of the Medicare, Medicaid,
and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA”), for tests performed after January 1, 2001 that
the Secretary of Health and Human Services determines are new tests for which no limitation amount has previously been established,
the cap is set at 100% of the median.
Medicare, Medicaid and other government program
payment reductions will not currently have a direct adverse effect on the Company's net earnings and cash flows, due to insignificant
revenue earned, however, it is not currently possible to project what impact will be had in future years.
In addition to reimbursement rates, the Company
is also impacted by changes in coverage policies for laboratory tests. Congressional action in 1997 required the Department of
Health and Human Services (“HHS”) to adopt uniform coverage, administration and payment policies for many of the most
commonly performed lab tests using a negotiated rulemaking process. The negotiated rulemaking committee established uniform policies
limiting Medicare coverage for certain tests to patients with specified medical conditions or diagnoses, replacing local Medicare
coverage policies which varied around the country. The final rules generally became effective in 2002, and the use of uniform policies
improves the Company's ability to obtain necessary billing information in some cases, but Medicare, Medicaid and private payer
diagnosis code requirements and payment policies continue to negatively impact the Company's ability to be paid for some of the
tests it performs. Due to the range of payers and policies, the extent of this impact continues to be difficult to quantify.
Future changes in federal,
state and local laws and regulations (or in the interpretation of current regulations) affecting government payment for clinical
laboratory testing could have a material adverse effect on the Company. In March 2010, comprehensive healthcare legislation, the
Patient Protection and Affordable Care Act (“ACA”), was enacted. Numerous proposals continue to be discussed in Congress
and the administration to repeal, amend or replace the ACA. Based on currently available information, the Company is unable to
predict what type of changes in legislation or regulations, if any, will occur.
Standard Electronic Transactions, Security and Confidentiality
of Health Information and Other Personal Information
The Health Insurance Portability and Accountability
Act of 1996 (“HIPAA”) was designed to address issues related to the security and confidentiality of health insurance
information. In an effort to improve the efficiency and effectiveness of the health care system by facilitating the electronic
exchange of information in certain financial and administrative transactions, HIPAA regulations were promulgated. These regulations
apply to health plans, health care providers that conduct standard transactions electronically and health care clearinghouses (“covered
entities”). Five such regulations have been finalized: (i) the Transactions and Code Sets Rule; (ii) the Privacy Rule; (iii)
the Security Rule; (iv) the Standard Unique Employer Identifier Rule, which requires the use of a unique employer identifier in
connection with certain electronic transactions; and (v) the National Provider Identifier Rule, which requires the use of a unique
health care provider identifier in connection with certain electronic transactions.
The Privacy Rule regulates the use and disclosure
of protected health information (“PHI”) by covered entities. It also sets forth certain rights that an individual has
with respect to his or her PHI maintained by a covered entity, such as the right to access or amend certain records containing
PHI or to request restrictions on the use or disclosure of PHI. The Privacy Rule requires covered entities to contractually bind
third parties, known as business associates, in the event that they perform an activity or service for or on behalf of the covered
entity that involves access to PHI. The Security Rule establishes requirements for safeguarding patient information that is electronically
transmitted or electronically stored. The Company believes that it is in compliance in all material respects with the requirements
of the HIPAA Privacy and Security Rules.
The Federal Health Information Technology for
Economic and Clinical Health Act (“HITECH”), which was enacted in February 2009, with regulations effective on September
23, 2013, strengthens and expands the HIPAA Privacy and Security Rules and their restrictions on use and disclosure of PHI. HITECH
includes, but is not limited to, prohibitions on exchanging PHI for remuneration, and additional restrictions on the use of PHI
for marketing. HITECH also fundamentally changes a business associate's obligations by imposing a number of Privacy Rule requirements
and a majority of Security Rule provisions directly on business associates that were previously only directly applicable to covered
entities. Moreover, HITECH requires covered entities to provide notice to individuals, HHS, and, as applicable, the media when
PHI is breached, as that term is defined by HITECH. Business associates are similarly required to notify covered entities of a
breach. The Company believes its policies and procedures are fully compliant with the HITECH requirements.
On February 6, 2014, the CMS and HHS published
final regulations that amended the HIPAA Privacy Rule to provide individuals (or their personal representatives) with the right
to receive copies of their test reports from laboratories subject to HIPAA, or to request that copies of their test reports be
transmitted to designated third parties. Previously, laboratories that were CLIA-certified or CLIA-exempt were not subject to the
provision in the Privacy Rule that provides individuals with the right of access to PHI. The HIPAA Privacy Rule amendment resulted
in the preemption of a number of state laws that prohibit a laboratory from releasing a test report directly to the individual.
The Company revised its policies and procedures to comply with these new access requirements and has updated its privacy notice
to reflect individuals' new access rights under this final rule.
The standard unique employer identifier regulations
require that employers have standard national numbers that identify them on standard transactions. The Employer Identification
Number, also known as a Federal Tax Identification Number, issued by the Internal Revenue Service, was selected as the identifier
for employers and was adopted effective July 30, 2002. The Company believes it is in compliance with these requirements.
The administrative simplification provisions
of HIPAA mandate the adoption of standard unique identifiers for health care providers. The intent of these provisions is to improve
the efficiency and effectiveness of the electronic transmission of health information. The National Provider Identification Rule
requires that all HIPAA-covered health care providers, whether they are individuals or organizations, must obtain a National Provider
Identifier (“NPI”) to identify themselves in standard HIPAA transactions. NPI replaces the unique provider identification
number - as well as other provider numbers previously assigned by payers and other entities - for the purpose of identifying providers
in standard electronic transactions. The Company believes that it is in compliance with the HIPAA National Provider Identification
Rule in all material respects.
The total cost associated with the requirements
of HIPAA and HITECH is not expected to be material to the Company's operations or cash flows. However, future regulations and interpretations
of HIPAA and HITECH could impose significant costs on the Company.
In addition to the HIPAA regulations described
above, there are a number of other Federal and state laws regarding the confidentiality and security of medical information, some
of which apply to clinical laboratories. These laws vary widely, but they most commonly regulate or restrict the collection, use
and disclosure of medical and financial information and other personal information. In some cases, state laws are more restrictive
than and therefore not preempted by HIPAA. Penalties for violation of these laws may include sanctions against a laboratory's licensure,
as well as civil and/or criminal penalties. Violations of the HIPAA provisions could result in civil and/or criminal penalties,
including significant fines and up to 10 years in prison. HITECH also significantly strengthened HIPAA enforcement. It increased
the civil penalty amounts that may be imposed, required HHS to conduct periodic audits to confirm compliance and also authorized
state attorneys general to bring civil actions seeking either injunctions or damages in response to violations of the HIPAA privacy
and security regulations that affect the privacy of state residents. Additionally, numerous other countries have or are developing
similar laws governing the collection, use, disclosure and transmission of personal and/or patient information.
The Company believes that it is in compliance
in all material respects with the current Transactions and Code Sets Rule. The Company implemented Version 5010 of the HIPAA Transaction
Standards and believes it has fully adopted the ICD-10-CM code set. The compliance date for ICD-10-CM was October 1, 2015. The
costs associated with ICD-10-CM Code Set were substantial, and failure of the Company, third party payers or physicians to apply
the new code set could have an adverse impact on reimbursement, day’s sales outstanding and cash collections. As a result
of inconsistent application of transaction standards by payers or the Company's inability to obtain certain billing information
not usually provided to the Company by physicians, the Company could face increased costs and complexity, a temporary disruption
in receipts and ongoing reductions in reimbursements and net revenues.
The Company believes it is in compliance in
all material respects with the Operating Rules for electronic funds transfers and remittance advice transactions, for which the
compliance date was January 1, 2014.
Fraud and Abuse Laws and Regulations
Existing federal laws governing federal health
care programs, including Medicare and Medicaid, as well as similar state laws, impose a variety of broadly described fraud and
abuse prohibitions on health care providers, including clinical laboratories. These laws are interpreted liberally and enforced
aggressively by multiple government agencies, including the U.S. Department of Justice, HHS' Office of Inspector General (“OIG”),
and various state agencies. Historically, the clinical laboratory industry has been the focus of major governmental enforcement
initiatives. The federal government's enforcement efforts have been increasing over the past decade, in part as a result of the
enactment of HIPAA, which included several provisions related to fraud and abuse enforcement, including the establishment of a
program to coordinate and fund federal, state and local law enforcement efforts. The Deficit Reduction Act of 2005 also included
new requirements directed at Medicaid fraud, including increased spending on enforcement and financial incentives for states to
adopt false claims act provisions similar to the federal False Claims Act. Recent amendments to the False Claims Act, as well as
other enhancements to the federal fraud and abuse laws enacted as part of the ACA, are widely expected to further increase fraud
and abuse enforcement efforts. For example, the ACA established an obligation to report and refund overpayments from Medicare within
60 days of identification (whether or not paid through any fault of the recipient); failure to comply with this new requirement
can give rise to additional liability under the False Claims Act and Civil Monetary Penalties statute. On February 11, 2016, CMS
issued the final rule clarifying certain aspects of the overpayment requirement for purposes of Medicare, effective on March 14,
2016.
The federal health care programs’ anti-kickback
law (the “Anti-Kickback Law”) prohibits knowingly providing anything of value in return for, or to induce the referral
of, Medicare, Medicaid or other federal health care program business. Violations can result in imprisonment, fines, penalties,
and/or exclusion from participation in federal health care programs. The OIG has published “safe harbor” regulations
which specify certain arrangements that are protected from prosecution under the Anti-Kickback Law if all conditions of the relevant
safe harbor are met. Failure to fit within a safe harbor does not necessarily constitute a violation of the Anti-Kickback Law;
rather, the arrangement would be subject to scrutiny by regulators and prosecutors and would be evaluated on a case by case basis.
Many states have their own Medicaid anti-kickback laws and several states also have anti-kickback laws that apply to all payers
(i.e., not just government health care programs).
From time to time, the OIG issues alerts and
other guidance on certain practices in the health care industry that implicate the Anti-Kickback Law or other federal fraud and
abuse laws. Examples of such guidance documents particularly relevant to the Company and its operations follow.
In October 1994, the OIG issued a Special Fraud
Alert on arrangements for the provision of clinical laboratory services. The Fraud Alert set forth a number of practices allegedly
engaged in by some clinical laboratories and health care providers that raise issues under the federal fraud and abuse laws, including
the Anti-Kickback Law. These practices include: (i) providing employees to furnish valuable services for physicians (other than
collecting patient specimens for testing) that are typically the responsibility of the physicians' staff; (ii) offering certain
laboratory services at prices below fair market value in return for referrals of other tests which are billed to Medicare at higher
rates; (iii) providing free testing to physicians' managed care patients in situations where the referring physicians benefit from
such reduced laboratory utilization; (iv) providing free pick-up and disposal of bio-hazardous waste for physicians for items unrelated
to a laboratory's testing services; (v) providing general-use facsimile machines or computers to physicians that are not exclusively
used in connection with the laboratory services; and (vi) providing free testing for health care providers, their families and
their employees (i.e., so-called “professional courtesy” testing). The OIG emphasized in the Special Fraud Alert that
when one purpose of such arrangements is to induce referrals of program-reimbursed laboratory testing, both the clinical laboratory
and the health care provider (e.g., physician) may be liable under the Anti-Kickback Law, and may be subject to criminal prosecution
and exclusion from participation in the Medicare and Medicaid programs. More recently, in June 2014, the OIG issued another Special
Fraud Alert addressing compensation paid by laboratories to referring physicians for blood specimen processing and for submitting
patient data to registries. This Special Fraud Alert reiterates the OIG’s longstanding concerns about payments from laboratories
to physicians in excess of the fair market value of the physician’s services and payments that reflect the volume or value
of referrals of federal healthcare program business.
Another issue the OIG has expressed concern
about involves the provision of discounts on laboratory services billed to customers in return for the referral of federal health
care program business. In a 1999 Advisory Opinion, the OIG concluded that a proposed arrangement whereby a laboratory would offer
physicians significant discounts on non-federal health care program laboratory tests might violate the Anti-Kickback Law. The OIG
reasoned that the laboratory could be viewed as providing such discounts to the physician in exchange for referrals by the physician
of business to be billed by the laboratory to Medicare at non-discounted rates. The OIG indicated that the arrangement would not
qualify for protection under the discount safe harbor to the Anti-Kickback Law because Medicare and Medicaid would not get the
benefit of the discount. Similarly, in a 1999 correspondence, the OIG stated that if any direct or indirect link exists between
a discounts that a laboratory offers to a skilled nursing facility (“SNF”) for tests covered under Medicare's payments
to the SNF and the referral of tests billable by the laboratory under Medicare Part B, then the Anti-Kickback Law would be implicated.
The OIG also has issued guidance regarding
joint venture arrangements that may be viewed as suspect under the Anti-Kickback Law. These documents have relevance to clinical
laboratories that are part of (or are considering establishing) joint ventures with potential sources of federal health care program
business. The first guidance document, which focused on investor referrals to such ventures, was issued in 1989 and another concerning
contractual joint ventures was issued in April 2003. Some of the elements of joint ventures that the OIG identified as “suspect”
include: arrangements in which the capital invested by the physicians is disproportionately small and the return on investment
is disproportionately large when compared to a typical investment; specific selection of investors who are in a position to make
referrals to the venture; and arrangements in which one of the parties to the joint venture expands into a line of business that
is dependent on referrals from the other party (sometimes called “shell” joint ventures). In a 2004 advisory opinion,
the OIG expressed concern about a proposed joint venture in which a laboratory company would assist physician groups in establishing
off-site pathology laboratories. The OIG indicated that the physicians' financial and business risk in the venture was minimal
and that the physicians would contract out substantially all laboratory operations, committing very little in the way of financial,
capital, or human resources. The OIG was unable to exclude the possibility that the arrangement was designed to permit the laboratory
to pay the physician groups for their referrals, and therefore was unwilling to find that the arrangement fell within a safe harbor
or had sufficient safeguards to protect against fraud or abuse.
Violations of other fraud and abuse laws also
can result in exclusion from participation in federal health care programs, including Medicare and Medicaid. One basis for such
exclusion is an individual's or entity's submission of claims to Medicare or Medicaid that are substantially in excess of that
individual's or entity’s usual charges for like items or services. In 2003, the OIG issued a notice of proposed rulemaking
that would have defined the terms “usual charges” and “substantially in excess” in ways that might have
required providers, including the Company, to either lower their charges to Medicare and Medicaid or increase charges to certain
other payers to avoid the risk of exclusion. On June 18, 2007, however, the OIG withdrew the proposed rule, saying it preferred
to continue evaluating billing patterns on a case-by-case basis. In its withdrawal notice, the OIG also said it “remains
concerned about disparities in the amounts charged to Medicare and Medicaid when compared to private payers,” that it continues
to believe its exclusion authority for excess charges “provides useful backstop protection for the public fisc from providers
that routinely charge Medicare or Medicaid substantially more than their other customers,” and that it will continue to use
“all tools available … to address instances where Medicare or Medicaid are charged substantially more than other payers.”
An enforcement action by the OIG under this statutory exclusion basis or an enforcement by Medicaid officials of similar state
law restrictions could have a material adverse effect on the Company.
Under another federal statute, known as the
“Stark Law” or “self-referral” prohibition, physicians who have a financial or compensation relationship
with a clinical laboratory may not, unless an exception applies, refer Medicare patients for testing to the laboratory, regardless
of the intent of the parties. Similarly, laboratories may not bill Medicare for services furnished pursuant to a prohibited self-referral.
There are several Stark Law exceptions that 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) an exception for certain ancillary services (including laboratory services) provided within the referring physician's own office,
if certain criteria are satisfied; 4) physician investment in a company whose stock is traded on a public exchange and has stockholder
equity exceeding $75.0 million; and 5) certain space and equipment rental arrangements that are set at a fair market value rate
and satisfy other requirements. All of the requirements of a Stark Law exception must be met to take advantage of the exception.
Many states have their own self-referral laws as well, which in some cases apply to all patient referrals, not just government
reimbursement programs.
There are a variety of other types of federal
and state fraud and abuse laws, including laws prohibiting submission of false or fraudulent claims. The Company seeks to conduct
its business in compliance with all federal and state fraud and abuse laws. The Company is unable to predict how these laws will
be applied in the future, and no assurances can be given that its arrangements will not be subject to scrutiny under such laws.
Sanctions for violations of these laws may include exclusion from participation in Medicare, Medicaid and other federal health
care programs, significant criminal and civil fines and penalties, and loss of licensure. Any exclusion from participation in a
federal or state health care program, or any loss of licensure, arising from any action by any federal or state regulatory or enforcement
authority, would likely have a material adverse effect on the Company's business. In addition, any significant criminal or civil
penalty resulting from such proceedings could have a material adverse effect on the Company's business.
Environmental, Health and Safety
The Company is subject to licensing and regulation
under federal, state and local laws and regulations relating to the protection of the environment and human health and safety laws
and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and
radioactive materials. All Company laboratories are subject to applicable federal and state laws and regulations relating to biohazard
disposal of all laboratory specimens and the Company generally utilizes outside vendors for disposal of such specimens. In addition,
the federal Occupational Safety and Health Administration (“OSHA”) has established extensive requirements relating
to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens
such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing
and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to, and transmission
of, blood-borne pathogens.
On November 6, 2000, Congress passed the Needle
Stick Safety and Prevention Act, which required, among other things, that companies include in their safety programs the evaluation
and use of engineering controls such as safety needles if found to be effective at reducing the risk of needle stick injuries in
the workplace. The Company has implemented the use of safety needles at all of its service locations, where applicable.
Although the Company is not aware of any current
material non-compliance with such federal, state and local laws and regulations, failure to comply could subject the Company to
denial of the right to conduct business, fines, criminal penalties and/or other enforcement actions.
Drug Testing
There is no comprehensive federal law that
regulates drug testing in the private sector. The Drug-Free Workplace Act does impose certain employee education requirements on
companies that do business with the government, but it does not require testing, nor does it restrict testing in any way. Drug
testing is allowed under the Americans with Disabilities Act (ADA) because the ADA does not consider drug abuse a disability --
but the law does not regulate or prohibit testing. Instead of a comprehensive regulatory system, federal law provides for specific
agencies to adopt drug testing regulations for employers under their jurisdiction. As a general rule, testing is presumed to be
lawful unless there is a specific restriction in state or federal law.
Controlled Substances
The use of controlled substances in testing
for drugs of abuse is regulated by the Federal Drug Enforcement Administration.
Compliance Program
The Company continuously evaluates and monitors
its compliance with all Medicare, Medicaid and other rules and regulations. The objective of the Company's compliance program is
to develop, implement, and update compliance safeguards as necessary. Emphasis is placed on developing and implementing compliance
policies and guidelines, personnel training programs and various monitoring and audit procedures to attempt to achieve implementation
of all applicable rules and regulations.
The Company seeks to conduct its business in
compliance with all statutes, regulations, and other requirements applicable to its clinical laboratory operations. The clinical
laboratory testing industry is, however, subject to extensive regulation, and many of these statutes and regulations have not been
interpreted by the courts. There can be no assurance that applicable statutes and regulations will not be interpreted or applied
by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect the Company. Potential sanctions for
violation of these statutes and regulations include significant fines and the loss of various licenses, certificates, and authorizations,
which could have a material adverse effect on the Company's business.
Employees
As of March 8, 2017, we have 116 employees,
of which 94 are full time. Of our total employees, 20 are assigned to laboratory operations, 23 are assigned to information technology,
44 are assigned to sales and customer service, 22 are assigned to medical billing and corporate administration, and seven are assigned
to the hospital. We continue to adjust our number of employees to achieve efficiencies and cost savings where applicable and expect
to employ approximately 120 people in the hospital project when it is in full operation.
Available Information
We are required to file Annual Reports on Form 10-K
and Quarterly Reports on Form 10-Q with the SEC on a regular basis and are required to disclose certain material events in
a Current Report on Form 8-K. All reports of the Company filed with the SEC are available free of charge through the SEC's
Web site at http://www.sec.gov. In addition, the public may read and copy materials filed by the Company at the SEC's Public Reference
Room located at 100 F Street, N.E., Washington, D.C. 20549. The public may also obtain additional information on the operation
of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
An investment in our securities is highly speculative
and subject to numerous and substantial risks. These risks include those set forth herein. You should carefully consider the risks
and uncertainties described below and the other information in this Annual Report before you decide to invest in our securities.
If any of the following events actually occur, our business could be materially harmed. In such case, the value of your investment
may decline and you may lose or all part of your investment. You should not invest in our securities unless you can afford the
loss of your entire investment.
Although our
financial statements have been prepared on a going concern basis, we have recently accumulated significant losses and have negative
cash flows from operations, which raise substantial doubt about our ability to continue as a going concern.
If we are unable to
improve our liquidity position we may not be able to continue as a going concern. The accompanying consolidated financial statements
do not include any adjustments that might result if we are unable to continue as a going concern and, therefore, be required to
realize our assets and discharge our liabilities other than in the normal course of business which could cause investors to suffer
the loss of all or a substantial portion of their investment.
The Company has recently accumulated significant
losses and has negative cash flows from operations, and at December 31, 2016 had a working capital deficit and stockholders’
deficit of $16.3 million and $14.9 million, respectively. For the years ended December 31, 2016 and 2015, we incurred net losses
attributable to common stockholders in the amount of $32.6 million and $37.6 million, respectively. In addition, the Company's
cash position is critically deficient, critical payments are not being made in the ordinary course, the Company is in default
of two promissory notes with an aggregate principal amount of $0.4 million and additional indebtedness in the amount of $6.0 million
matured on March 31, 2017 (see note 7 to the consolidated financial statements). This indebtedness is secured by receivables that
we have filed suit to recover from a national payer and while we believe that we will be successful in such recovery there can
be no assurances as to our ability to collect on these receivables, and the Company does not have the financial resources to satisfy
this indebtedness. All of the foregoing raises substantial doubt about the Company's ability to continue as a going concern.
The Company is currently
executing on a plan of action to reduce the number of laboratory facilities it operates from five such facilities as of December
31, 2015 into one, with a corresponding reduction in the number of employees and associated operating expenses, in order to reduce
costs. In addition, the Company issued $12.4 million of convertible notes in the first three months of 2017, for which it received
net proceeds of $9.9 million. There can be no assurance, however, that the Company will be able to achieve its business plan, raise
any additional capital or secure the additional financing necessary to implement its current operating plan. The ability
of the Company to continue as a going concern is dependent upon its ability to significantly reduce its operating costs, increase
its revenues and eventually regain profitable operations. The accompanying consolidated financial statements do not include any
adjustments that might be necessary if the Company is unable to continue as a going concern.
Our common stock could be delisted from
NASDAQ.
On January 11, 2017, we were notified by Nasdaq
that we no longer comply with Nasdaq's audit committee requirements as set forth in Nasdaq Listing Rule 5605 (the "Rule"),
which requires the audit committee of the Company's board of directors to have at least three members, each of whom must be independent
directors as defined under the Rule. With the passing of Benjamin Frank in December of 2016, our audit committee currently consists
of two independent directors. In accordance with Nasdaq Rule 5605(c)(4), we have until the earlier of our next annual shareholders'
meeting or December 18, 2017 to regain compliance; or, if our next annual shareholders' meeting is held before June 16, 2017, then
we must evidence compliance no later than June 16, 2017. If we do not regain compliance by the foregoing applicable dates, then
Nasdaq will provide written notification to the Company that its securities will be delisted.
In the future, our common stock may fall below
the NASDAQ listing requirements or we may not comply with other listing requirements, with the result being that our common stock
may be delisted. If our common stock is delisted, we may list our common stock for trading over the counter. Delisting from NASDAQ
could adversely affect the liquidity and price of our common stock. A determination could also then be made that our common stock
is a “penny stock” which would require brokers trading in our common stock to adhere to more stringent rules and possibly
result in a reduced level of trading. This could have a long-term impact on our ability to raise future capital through the sale
of our common stock.
Our acquisition of the Hospital Assets
does not provide assurance that the acquired operations will be accretive to our earnings or otherwise improve our results of operations.
Acquisitions, such as that of the Hospital
Assets in January of 2017, involve the integration of previously separate businesses into a common enterprise in which it is envisioned
that synergistic operations will be result in improved financial performance. However, realization of these envisioned results
is subject to numerous risks and uncertainties, including but not limited to:
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Diversion of management time
and attention from daily operations;
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Difficulties integrating the acquired
business, technologies and personnel into our business;
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Potential loss of key employees, key contractual
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Exposure to unforeseen liabilities
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There is no assurance that the acquisition
of the Hospital Assets will be accretive to our earnings or otherwise improve our results of operations.
The opening of Big South Fork Medical
Center is subject to the receipt of necessary licenses and regulatory approvals and will require continued investment by the Company.
We acquired the Hospital Assets on January
13, 2017, and we expect to have the hospital (now renamed as Big South Fork Medical Center) open in part in the second quarter
of 2017, and that the hospital will be fully operational by the third quarter of 2017, although no assurance can be given that
either of these time frames will be met. Opening and operating a hospital requires numerous licenses and regulatory approvals and
the failure to receive one such license or approval may prevent the hospital from opening. The process of gaining all such licenses
and approvals may take a substantial amount of time.
The reopening of the hospital will require
substantial investment by the Company and we may not have the funds or be able to access such funds when necessary. We will need
to fully fund the operations of the hospital out of our own resources for an extended period because the hospital will not receive
reimbursement for any services for a number of months after they are performed, or otherwise generate any positive cash flow. Because
the hospital has been closed since July 2016, it could take a long period of time for utilization of the hospital to reach pre-closure
levels, and no assurance can be made that it will do so or that utilization will be sufficient to cover the costs of operating
the hospital.
Our results of operations
may be adversely affected if the ACA is repealed, replaced or otherwise changed.
The ACA has increased the
number of people with health care insurance. It also has reduced Medicare and Medicaid reimbursements. Numerous proposals continue
to be discussed in Congress and the administration to repeal, amend or replace the law. We cannot predict whether any such repeal,
amend or replace proposals, or any parts of them, will become law and, if they do, what their substance or timing will be. Any
of the foregoing, if they occur, could have a material adverse effect on our business and results of operations.
Our business could be harmed from the
loss or suspension of a license or imposition of a fine or penalties under, or future changes or changing interpretations of, CLIA
or state laboratory licensing laws to which we are subject.
The clinical laboratory testing industry is
subject to extensive federal and state regulation, and many of these statutes and regulations have not been interpreted by the
courts. The Clinical Laboratory Improvement Amendments of 1988, or CLIA, are federal regulatory standards that apply to virtually
all clinical laboratories (regardless of the location, size or type of laboratory), including those operated by physicians in their
offices, by requiring that they be certified by the federal government or by a federally approved accreditation agency. CLIA does
not preempt state law, which in some cases may be more stringent than federal law and require additional personnel qualifications,
quality control, record maintenance and proficiency testing. The sanction for failure to comply with CLIA and state requirements
may be suspension, revocation or limitation of a laboratory's CLIA certificate, which is necessary to conduct business, as well
as significant fines and/or criminal penalties. Many other states have similar laws and we may be subject to similar penalties.
We cannot assure you that applicable statutes
and regulations will not be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would
adversely affect our business. Potential sanctions for violation of these statutes and regulations include significant fines and
the suspension or loss of various licenses, certificates and authorizations, which could have a material adverse effect on our
business. In addition, compliance with future legislation could impose additional requirements on us, which may be costly.
Healthcare plans have taken steps to
control the utilization and reimbursement of healthcare services, including clinical test services.
We also face efforts by non-governmental third-party
payers, including healthcare plans, to reduce utilization and reimbursement for clinical testing services.
The healthcare industry has experienced a trend
of consolidation among healthcare insurance plans and payers, resulting in fewer but larger insurance plans with significant bargaining
power to negotiate fee arrangements with healthcare providers, including clinical testing providers. These healthcare plans, and
independent physician associations, may demand that clinical testing providers accept discounted fee structures or assume all or
a portion of the financial risk associated with providing testing services to their members through capped payment arrangements.
In addition, some healthcare plans have been willing to limit the PPO or Point of Service (“POS”) laboratory network
to only a single national laboratory to obtain improved fee-for-service pricing. There are also an increasing number of patients
enrolling in consumer driven products and high deductible plans that involve greater patient cost-sharing.
The increased consolidation among healthcare
plans and payers increases the potential adverse impact of ceasing to be a contracted provider with any such insurer. The Health
Care Reform Law includes provisions, including ones regarding the creation of healthcare exchanges, which may encourage healthcare
insurance plans to increase exclusive contracting.
We expect continuing efforts to reduce reimbursements,
to impose more stringent cost controls and to reduce utilization of clinical test services. These efforts, including future changes
in third-party payer rules, practices and policies or ceasing to be a contracted provider to many healthcare plans, have had and
may continue to have a material adverse effect on our business.
Unless we raise sufficient funds, we
will not be able to succeed in our business model.
During the year ended December 31, 2016 and
through the date of this report, we have relied on the sale of our equity securities and from short term advances from one of our
directors, Christopher Diamantis, to fund our operations. We generated negative cash flow from operating activities for the years
ended December 31, 2016 and 2015. If this trend were to continue and we are unable to raise sufficient capital to fund our operations
through other sources, our business will be adversely effected, and we may not be able to continue as a going concern (see Item
7.,
Management’s Discussion and Analysis of Financial Condition and Results of Operations
, “Liquidity and Capital
Resources”). There can be no assurances that we will be able to raise sufficient funds on terms that are acceptable to us,
or at all, to fund our operations under our current business model.
Regulation by the FDA of LDTs and clinical
laboratories may result in significant change, and our business could be adversely impacted if we fail to adapt.
High complexity, CLIA-certified
laboratories, such as ours, frequently develop testing procedures to provide diagnostic results to customers. These tests
have been traditionally offered by nearly all complex laboratories for the last few decades and LDTs are subject to CMS oversight
through its enforcement of CLIA. The FDA, which regulates the development and use of medical devices, has claimed that it
has regulatory authority over LDTs, but has not exercised enforcement with respect to most LDTs offered by high complexity laboratories,
and not sought to require these laboratories to comply with FDA regulations regarding medical devices. During 2010, the FDA
publicly announced that it has decided to exercise regulatory authority over these LDTs, and that it plans to issue guidance to
the industry regarding its regulatory approach. At that time, the FDA indicated that it would use a risk-based approach to regulation
and would direct more resources to tests with wider distribution and with the highest risk of injury, but that it will be sensitive
to the need to not adversely impact patient care or innovation. In September 2014, the FDA announced its framework and timetable
for implementing this guidance. On November 18, 2016, the FDA announced it would not release final guidance at this time and instead
would continue to work with stakeholders, the new administration and Congress to determine the right approach, and on January 3,
2017, the FDA released a discussion paper outlining a possible risk-based approach for FDA and CMS oversight of LDTs. We cannot
predict the ultimate timing or form of any such guidance or regulation or their potential impact. If adopted, such a regulatory
approach by the FDA may lead to an increased regulatory burden, including additional costs and delays in introducing new tests.
While the ultimate impact of the FDA's approach is unknown, it may be extensive and may result in significant change. Our failure
to adapt to these changes could have a material adverse effect on our business.
Some of our operations are subject to
federal and state laws prohibiting “kickbacks” and other laws designed to prohibit payments for referrals and eliminate
healthcare fraud.
Federal and state anti-kickback and similar
laws prohibit payment, or offers of payment, in exchange for referrals of products and services for which reimbursement may be
made by Medicare or other federal and state healthcare programs. Some state laws contain similar prohibitions that apply without
regard to the payer of reimbursement for the services. Under a federal statute, known as the “Stark Law” or “self-referral”
prohibition, physicians, subject to certain exceptions, are prohibited from referring their Medicare or Medicaid program patients
to clinical laboratories with which the physicians or their immediate family members have a financial relationship, and the laboratories
are prohibited from billing for services rendered in violation of Stark Law referral prohibitions. Violations of the federal Anti-Kickback
Law and Stark Law may be punished by civil and criminal penalties, and/or exclusion from participation in federal health care programs,
including Medicare and Medicaid. States may impose similar penalties. The Health Care Reform Law significantly strengthened
provisions of the Federal False Claims Act and Anti-Kickback Law provisions, and other health care fraud provisions, leading to
the possibility of greatly increased qui tam suits by private citizen “relators” for perceived violations of these
laws. There can be no assurance that our activities will not come under the scrutiny of regulators and other government authorities
or that our practices will not be found to violate applicable laws, rules and regulations or prompt lawsuits by private citizen
relators under federal or state false claims laws.
Federal officials responsible for administering
and enforcing the healthcare laws and regulations have made a priority of eliminating healthcare fraud. For example, the Health
Care Reform Law includes significant new fraud and abuse measures, including required disclosures of financial arrangements with
physician customers, lower thresholds for violations and increased potential penalties for violations. Federal funding available
for combating health care fraud and abuse generally has increased. While we seek to conduct our business in compliance with all
applicable laws and regulations, many of the laws and regulations applicable to our business, particularly those relating to billing
and reimbursement of tests and those relating to relationships with physicians, hospitals and patients, contain language that has
not been interpreted by courts. We must rely on our interpretation of these laws and regulations based on the advice of our counsel
and regulatory or law enforcement authorities may not agree with our interpretation of these laws and regulations and may seek
to enforce legal remedies or penalties against us for violations.
From time to time we may need to change our
operations, particularly pricing or billing practices, in response to changing interpretations of these laws and regulations, or
regulatory or judicial determinations with respect to these laws and regulations. These occurrences, regardless of their outcome,
could damage our reputation and harm important business relationships that we have with healthcare providers, payers and others.
Furthermore, if a regulatory or judicial authority finds that we have not complied with applicable laws and regulations, we would
be required to refund amounts that were billed and collected in violation of such laws and regulations. In addition, we may voluntarily
refund amounts that were alleged to have been billed and collected in violation of applicable laws and regulations. In either case,
we could suffer civil and criminal damages, fines and penalties, exclusion from participation in governmental healthcare programs
and the loss of licenses, certificates and authorizations necessary to operate our business, as well as incur liabilities from
third-party claims, all of which could harm our operating results and financial condition.
Moreover, regardless of the outcome, if we
or physicians or other third parties with whom we do business are investigated by a regulatory or law enforcement authority we
could incur substantial costs, including legal fees, and our management may be required to divert a substantial amount of time
to an investigation.
To enhance compliance with applicable health
care laws, and mitigate potential liability in the event of noncompliance, regulatory authorities, such as the OIG, have recommended
the adoption and implementation of a comprehensive health care compliance program that generally contains the elements of an effective
compliance and ethics program described in Section 8B2.1 of the United States Sentencing Commission Guidelines Manual, and
for many years the OIG has made available a model compliance program targeted to the clinical laboratory industry. In addition,
certain states require that health care providers, such as clinical laboratories, that engage in substantial business under the
state Medicaid program have a compliance program that generally adheres to the standards set forth in the Model Compliance Program.
Also, under the Health Care Reform Law, the U.S. Department of Health and Human Services, or HHS, will require suppliers, such
as the Company, to adopt, as a condition of Medicare participation, compliance programs that meet a core set of requirements. While
we have adopted, or are in the process of adopting, healthcare compliance and ethics programs that generally incorporate the OIG's
recommendations, and training our applicable employees in such compliance, having such a program can be no assurance that we will
avoid any compliance issues.
We conduct our clinical laboratory testing
business in a heavily regulated industry and changes in regulations or violations of regulations could, directly or indirectly,
harm our operating results and financial condition.
The clinical laboratory testing industry is
highly regulated and there can be no assurance that the regulatory environment in which we operate will not change significantly
and adversely in the future. Areas of the regulatory environment that may affect our ability to conduct business include, without
limitation:
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federal and state laws applicable to billing and claims payment;
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federal and state laboratory anti-mark-up laws;
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federal and state anti-kickback laws;
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federal and state false claims laws;
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federal and state self-referral and financial inducement laws, including the federal physician anti-self-referral law, or the Stark Law;
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coverage and reimbursement levels by Medicare and other governmental payors and private insurers;
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federal and state laws governing laboratory licensing and testing, including CLIA;
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federal and state laws governing the development, use and distribution of diagnostic medical tests known as laboratory developed tests or “LDTs”;
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HIPAA, along with the revisions to HIPAA as a result of the HITECH Act, and analogous state laws;
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federal, state and foreign regulation of privacy, security, electronic transactions and identity theft;
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federal, state and local laws governing the handling, transportation and disposal of medical and hazardous waste;
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Occupational Safety and Health Administration rules and regulations;
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changes to laws, regulations and rules as a result of the Health Care Reform Law; and
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changes to other federal, state and local laws, regulations and rules, including tax laws.
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These laws and regulations are extremely complex
and in many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. Any determination
that we have violated these laws or regulations, or the public announcement that we are being investigated for possible violations
of these laws or regulations, could harm our operating results and financial condition. In addition, a significant change in any
of these laws or regulations may require us to change our business model in order to maintain compliance with these laws or regulations,
which could harm our operating results and financial condition.
Failure to comply with complex federal
and state laws and regulations related to submission of claims for clinical laboratory services can result in significant monetary
damages and penalties and exclusion from the Medicare and Medicaid Programs.
We are subject to extensive federal and state
laws and regulations relating to the submission of claims for payment for clinical laboratory services, including those that relate
to coverage of our services under Medicare, Medicaid and other governmental health care programs, the amounts that may be billed
for our services and to whom claims for services may be submitted.
Our failure to comply with applicable laws
and regulations could result in our inability to receive payment for our services or result in attempts by third-party payers,
such as Medicare and Medicaid, to recover payments from us that have already been made. Submission of claims in violation of certain
statutory or regulatory requirements can result in penalties, including substantial civil money penalties for each item or service
billed to Medicare in violation of the legal requirement, and exclusion from participation in Medicare and Medicaid. Government
authorities may also assert that violations of laws and regulations related to submission or causing the submission of claims violate
the federal False Claims Act (“FCA”) or other laws related to fraud and abuse, including submission of claims for services
that were not medically necessary. Violations of the FCA could result in enormous economic liability. The FCA provides that all
damages are trebled, and each false claim submitted is subject to a penalty of up to $11,000. For example, we could be subject
to FCA liability if it was determined that the services we provided were not medically necessary and not reimbursable, particularly
if it were asserted that we contributed to the physician's referrals of unnecessary services to us. It is also possible that the
government could attempt to hold us liable under fraud and abuse laws for improper claims submitted by an entity for services that
we performed if we were found to have knowingly participated in the arrangement that resulted in submission of the improper claims.
We continuously conduct internal audits on
current and historical billings to protect against errors related to any of the above. One of these audits has led us to retain
an independent consulting firm to assess if any violations to the foregoing regulations have occurred in the historical billings
by our laboratories. If the review determines that any overpayment was received, we will inform the relative party and make arrangements
to repay any overpayment.
Changes in regulation and policies, including
increasing downward pressure on health care reimbursement, may adversely affect reimbursement for diagnostic services and could
have a material adverse impact on our business.
Reimbursement levels for health care services
are subject to continuous and often unexpected changes in policies, and we face a variety of efforts by government payers to reduce
utilization and reimbursement for diagnostic testing services. Changes in governmental reimbursement may result from statutory
and regulatory changes, retroactive rate adjustments, administrative rulings, competitive bidding initiatives, and other policy
changes.
The U.S. Congress has considered, at least
yearly in conjunction with budgetary legislation, changes to the Medicare fee schedules under which we receive reimbursement. For
example, currently there is no copayment or coinsurance required for clinical laboratory services. However, Congress has periodically
considered imposing a 20 percent coinsurance on laboratory services. If enacted, this would require us to attempt to collect this
amount from patients, although in many cases the costs of collection would exceed the amount actually received.
The CMS pays laboratories on the basis of a
fee schedule that is reviewed and re-calculated on an annual basis. CMS may change the fee schedule upward or downward on billing
codes that we submit for reimbursement on a regular basis; our revenue and business may be adversely affected if the reimbursement
rates associated with such codes are reduced. Even when reimbursement rates are not reduced, policy changes add to our costs by
increasing the complexity and volume of administrative requirements. Medicaid reimbursement, which varies by state, is also subject
to administrative and billing requirements and budget pressures. Recently, state budget pressures have caused states to consider
several policy changes that may impact our financial condition and results of operations, such as delaying payments, reducing reimbursement,
restricting coverage eligibility and service coverage, and imposing taxes on our services.
Failure to timely or accurately bill
for our services could have a material adverse effect on our business.
Billing for clinical testing services is extremely
complicated and is subject to extensive and non-uniform rules and administrative requirements. Depending on the billing arrangement
and applicable law, we bill various payers, such as patients, insurance companies, Medicare, Medicaid, physicians, hospitals and
employer groups. Changes in laws and regulations could increase the complexity and cost of our billing process. Additionally, auditing
for compliance with applicable laws and regulations as well as internal compliance policies and procedures adds further cost and
complexity to the billing process. Further, our billing systems require significant technology investment and, as a result of marketplace
demands, we need to continually invest in our billing systems.
Missing, incomplete, or incorrect information
on requisitions adds complexity to and slows the billing process, creates backlogs of unbilled requisitions, and generally increases
the aging of accounts receivable and bad debt expense. Failure to timely or correctly bill may lead to our not being reimbursed
for our services or an increase in the aging of our accounts receivable, which could adversely affect our results of operations
and cash flows. Failure to comply with applicable laws relating to billing or even having to pay back amounts incorrectly billed
and collected could lead to various penalties, including: (1) exclusion from participation in CMS and other government programs;
(2) asset forfeitures; (3) civil and criminal fines and penalties; and (4) the loss of various licenses, certificates and authorizations
necessary to operate our business, any of which could have a material adverse effect on our results of operations or cash flows.
There have been times when our accounts receivables
have increased at a greater rate than revenue growth and, therefore, have adversely affected our cash flows from operations. We
have taken steps to implement systems and processing changes intended to improve billing procedures and related collection results.
However, we cannot assure that our ongoing assessment of accounts receivable will not result in the need for additional provisions.
Such additional provisions, if implemented, could have a material adverse effect on our operating results.
During the last half of 2014 and the first
three quarters of 2015, the Company experienced difficulty in delivering accurate electronic submissions to third party payers.
The difficulties arose from a variety of factors, including pressure, scrutiny and requirement for additional information from
payers related to toxicology services, difficulty complying with CMS’s new HCPCS codes for toxicology services, difficulty
in accurately billing for internal reference laboratory work, and complications arising from the implementation of new billing
technology. These difficulties have a significant impact on the time it takes the Company to collect its receivables and consequently
on its cash flow from operations. The Company believes that these difficulties were corrected in the fourth quarter of 2015, but
there can be no assurance that CMS and other third party payers will not change their requirements resulting in further billing
related difficulties.
Our operations may be adversely impacted
by the effects of extreme weather conditions, natural disasters such as hurricanes and earthquakes, health pandemics, hostilities
or acts of terrorism and other criminal activities.
Our operations are always subject to adverse
impacts resulting from extreme weather conditions, natural disasters, health pandemics, hostilities or acts of terrorism or other
criminal activities. Such events may result in a temporary decline in the number of patients who seek clinical testing services
or in our employees' ability to perform their job duties. In addition, such events may temporarily interrupt our ability to transport
specimens, to receive materials from our suppliers or otherwise to provide our services. The occurrence of any such event and/or
a disruption of our operations as a result may adversely affect our results of operations.
Increased competition, including price
competition, could have a material adverse impact on our net revenues and profitability.
We operate in a business that is characterized
by intense competition. Our major competitors include large national laboratories that possess greater name recognition, larger
customer bases, and significantly greater financial resources and employ substantially more personnel than we do. Many of our competitors
have long established relationships. We cannot assure you that we will be able to compete successfully with such entities in the
future.
The clinical laboratory business is intensely
competitive both in terms of price and service. Pricing of laboratory testing services is often one of the most significant factors
used by health care providers and third-party payers in selecting a laboratory. As a result of the clinical laboratory industry
undergoing significant consolidation, larger clinical laboratory providers are able to increase cost efficiencies afforded by large-scale
automated testing. This consolidation results in greater price competition. We may be unable to increase cost efficiencies sufficiently,
if at all, and as a result, our net earnings and cash flows could be negatively impacted by such price competition. We may also
face competition from companies that do not comply with existing laws or regulations or otherwise disregard compliance standards
in the industry. Additionally, we may also face changes in fee schedules, competitive bidding for laboratory services or other
actions or pressures reducing payment schedules as a result of increased or additional competition. Additional competition, including
price competition, could have a material adverse impact on our net revenues and profitability.
Failure to comply with environmental,
health and safety laws and regulations, including the federal Occupational Safety and Health Administration Act and the Needlestick
Safety and Prevention Act, could result in fines and penalties and loss of licensure, and have a material adverse effect upon the
Company's business.
The Company is subject to licensing and regulation
under federal, state and local laws and regulations relating to the protection of the environment and human health and safety,
including laws and regulations relating to the handling, transportation and disposal of medical specimens, and infectious and hazardous
waste materials, as well as regulations relating to the safety and health of laboratory employees. All of the Company's laboratories
are subject to applicable federal and state laws and regulations relating to biohazard disposal of all laboratory specimens, and
they utilize outside vendors for disposal of such specimens. In addition, the federal Occupational Safety and Health Administration
has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories,
whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These requirements, among other things,
require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures
designed to minimize exposure to, and transmission of, blood-borne pathogens. In addition, the Needlestick Safety and Prevention
Act requires, among other things, that the Company include in its safety programs the evaluation and use of emergency controls
such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace.
Failure to comply with federal, state and local
laws and regulations could subject the Company to denial of the right to conduct business, fines, criminal penalties and/or other
enforcement actions which would have a material adverse effect on its business. In addition, compliance with future legislation
could impose additional requirements on the Company which may be costly.
Regulations requiring the use of “standard
transactions” for health care services issued under HIPAA may negatively impact the Company's profitability and cash flows.
Pursuant to HIPAA, the Secretary of Health
and Human Services has issued regulations designed to improve the efficiency and effectiveness of the health care system by facilitating
the electronic exchange of information in certain financial and administrative transactions while protecting the privacy and security
of the information exchanged.
The HIPAA transaction standards are complex,
and subject to differences in interpretation by payers. For instance, some payers may interpret the standards to require the Company
to provide certain types of information, including demographic information not usually provided to the Company by physicians. As
a result of inconsistent application of transaction standards by payers or the Company's inability to obtain certain billing information
not usually provided to the Company by physicians, the Company could face increased costs and complexity, a temporary disruption
in receipts and ongoing reductions in reimbursements and net revenues. In addition, new requirements for additional standard transactions,
such as claims attachments and the ICD-10-CM Code Set, could prove technically difficult, time-consuming or expensive to implement.
Failure to maintain the security of customer-related
information or compliance with security requirements could damage the Company's reputation with customers, and cause it to incur
substantial additional costs and to become subject to litigation.
Pursuant to HIPAA and certain similar state
laws, we must comply with comprehensive privacy and security standards with respect to the use and disclosure of protected health
information. Under the HITECH amendments to HIPAA, HIPAA was expanded to require certain data breach notifications, to extend certain
HIPAA privacy and security standards directly to business associates, to heighten penalties for noncompliance and to enhance enforcement
efforts.
The Company receives certain personal and financial
information about its customers. In addition, the Company depends upon the secure transmission of confidential information over
public networks, including information permitting cashless payments. A compromise in the Company's security systems that results
in customer personal information being obtained by unauthorized persons or the Company's failure to comply with security requirements
for financial transactions could adversely affect the Company's reputation with its customers and others, as well as the Company's
results of operations, financial condition and liquidity. It could also result in litigation against the Company or the imposition
of penalties.
Failure
of the Company, third party payers or physicians to comply with the ICD-10-CM Code Set and our failure to comply with other emerging
electronic transmission standards could adversely affect our business.
The Company
believes that it is in compliance in all material respects with the current Transactions and Code Sets Rule. The Company implemented
Version 5010 of the HIPAA Transaction Standards, and believes it has fully adopted the ICD-10-CM code set. The compliance date
for ICD-10-CM was October 1, 2015. Clinical laboratories are typically required to submit health care claims with diagnosis codes
to third party payers. The diagnosis codes must be obtained from the ordering physician. The failure of the Company, third party
payers or physicians to transition within the required timeframe could have an adverse impact on reimbursement, day's sales outstanding
and cash collections.
Also, the failure of our IT systems to keep
pace with technological advances may significantly reduce our revenues or increase our expenses. Public and private initiatives
to create healthcare information technology ("HCIT") standards and to mandate standardized clinical coding systems for
the electronic exchange of clinical information, including test orders and test results, could require costly modifications to
our existing HCIT systems. While we do not expect HCIT standards to be adopted or implemented without adequate time to comply,
if we fail to adopt or delay in implementing HCIT standards, we could lose customers and business opportunities.
Compliance with the HIPAA security regulations
and privacy regulations may increase the Company's costs.
The HIPAA privacy and security regulations,
including the expanded requirements under HITECH, establish comprehensive federal standards with respect to the use and disclosure
of protected health information by health plans, healthcare providers and healthcare clearinghouses, in addition to setting standards
to protect the confidentiality, integrity and security of protected health information. The regulations establish a complex regulatory
framework on a variety of subjects, including:
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the circumstances under which the use and disclosure of protected health information are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, activities to obtain payments for the Company's services, and its healthcare operations activities;
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a patient's rights to access, amend and receive an accounting of certain disclosures of protected health information;
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the content of notices of privacy practices for protected health information;
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administrative, technical and physical safeguards required of entities that use or receive protected health information; and
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the protection of computing systems maintaining Electronic Personal Health Information (“ePHI”).
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The Company has implemented policies and procedures
related to compliance with the HIPAA privacy and security regulations, as required by law. The privacy and security regulations
establish a “floor” and do not supersede state laws that are more stringent. Therefore, the Company is required to
comply with both federal privacy and security regulations and varying state privacy and security laws. In addition, for healthcare
data transfers from other countries relating to citizens of those countries, the Company may also be required to comply with the
laws of those other countries. The federal privacy regulations restrict the Company's ability to use or disclose patient identifiable
laboratory data, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined
by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations.
HIPAA, as amended by HITECH, provides for significant fines and other penalties for wrongful use or disclosure of protected health
information in violation of the privacy and security regulations, including potential civil and criminal fines and penalties. Due
to the enactment of HITECH and an increase in the amount of monetary financial penalties, government enforcement has also increased.
It is not possible to predict what the extent of the impact on business will be, other than heightened scrutiny and emphasis on
compliance. If the Company does not comply with existing or new laws and regulations related to protecting the privacy and security
of health information it could be subject to significant monetary fines, civil penalties or criminal sanctions. In addition, other
federal and state laws that protect the privacy and security of patient information may be subject to enforcement and interpretations
by various governmental authorities and courts resulting in complex compliance issues. For example, the Company could incur damages
under state laws pursuant to an action brought by a private party for the wrongful use or disclosure of confidential health information
or other private personal information.
The clinical laboratory industry is subject
to changing technology and new product introductions.
Advances in technology may lead to the development
of more cost-effective technologies such as point-of-care testing equipment that can be operated by physicians or other healthcare
providers in their offices or by patients themselves without requiring the services of freestanding clinical laboratories. Development
of such technology and its use by the Company's customers could reduce the demand for its laboratory testing services and negatively
impact its revenues.
Currently, most clinical laboratory testing
is categorized as “high” or “moderate” complexity, and thereby is subject to extensive and costly regulation
under CLIA. The cost of compliance with CLIA makes it impractical for most physicians to operate clinical laboratories in their
offices, and other laws limit the ability of physicians to have ownership in a laboratory and to refer tests to such a laboratory.
Manufacturers of laboratory equipment and test kits could seek to increase their sales by marketing point-of-care laboratory equipment
to physicians and by selling test kits approved for home or physician office use to both physicians and patients. Diagnostic tests
approved for home use are automatically deemed to be “waived” tests under CLIA and may be performed in physician office
laboratories as well as by patients in their homes with minimal regulatory oversight. Other tests meeting certain FDA criteria
also may be classified as “waived” for CLIA purposes. The FDA has regulatory responsibility over instruments, test
kits, reagents and other devices used by clinical laboratories and has taken responsibility from the CDC for classifying the complexity
of tests for CLIA purposes. Increased approval of “waived” test kits could lead to increased testing by physicians
in their offices or by patients at home, which could affect the Company's market for laboratory testing services and negatively
impact its revenues.
Health care reform and related programs
(e.g. Health Insurance Exchanges), changes in government payment and reimbursement systems, or changes in payer mix, including
an increase in capitated reimbursement mechanisms and evolving delivery models, could have a material adverse impact on the Company's
net revenues, profitability and cash flow.
Testing services are billed to private patients,
Medicare, Medicaid, commercial clients, managed care organizations (“MCOs”) and third-party insurance companies. Tests
ordered by a physician may be billed to different payers depending on the medical insurance benefits of a particular patient. Most
testing services are billed to a party other than the physician or other authorized person that ordered the test. Increases in
the percentage of services billed to government and managed care payers could have an adverse impact on the Company's net revenues.
The various MCOs have different contracting
philosophies, which are influenced by the design of the products they offer to their members. Some MCOs contract with a limited
number of clinical laboratories and engage in direct negotiation of the rates reimbursed to participating laboratories. Other MCOs
adopt broader networks with a largely uniform fee structure offered to all participating clinical laboratories. In addition, some
MCOs have used capitation in an effort to fix the cost of laboratory testing services for their enrollees. Under a capitated reimbursement
mechanism, the clinical laboratory and the managed care organization agree to a per member, per month payment to pay for all authorized
laboratory tests ordered during the month by the physician for the members, regardless of the number or cost of the tests actually
performed. Capitation shifts the risk of increased test utilization (and the underlying mix of testing services) to the clinical
laboratory provider.
A portion of the third-party insurance fee-for-service
revenues are collectible from patients in the form of deductibles, copayments and coinsurance. As patient cost-sharing increases,
collectability may be impacted.
In addition, Medicare and Medicaid and private
insurers have increased their efforts to control the cost, utilization and delivery of health care services, including clinical
laboratory services. Measures to regulate health care delivery in general, and clinical laboratories in particular, have resulted
in reduced prices, added costs and decreased test utilization for the clinical laboratory industry by increasing complexity and
adding new regulatory and administrative requirements. Pursuant to legislation passed in late 2003, the percentage of Medicare
beneficiaries enrolled in Medicare managed care plans has increased. The percentage of Medicaid beneficiaries enrolled in Medicaid
managed care plans has also increased, and is expected to continue to increase. Changes to, or repeal of, the Health Care Reform
Law, the health care reform legislation passed in 2010, also may continue to affect coverage, reimbursement, and utilization of
laboratory services, as well as administrative requirements, in ways that are currently unpredictable.
The Company expects efforts to impose reduced
reimbursement, more stringent payment policies and cost controls by government and other payers to continue. If the Company cannot
offset additional reductions in the payments it receives for its services by reducing costs, increasing test volume and/or introducing
new procedures, it could have a material adverse impact on the Company's net revenues, profitability and cash flows.
As an employer, health care reform legislation
also contains numerous regulations that will require the Company to implement significant process and record keeping changes to
be in compliance. These changes increase the cost of providing healthcare coverage to employees and their families. Given the limited
release of regulations to guide compliance, as well as potential changes to or repeal of the Health Care Reform Law, the exact
impact to employers including the Company is uncertain.
A failure to obtain and retain new customers,
a loss of existing customers or material contracts, a reduction in tests ordered or specimens submitted by existing customers,
or the inability to retain existing and create new relationships with health systems could impact the Company's ability to successfully
grow its business.
To offset efforts by payers to reduce the cost
and utilization of clinical laboratory services and to otherwise grow its business, the Company needs to obtain and retain new
customers and business partners. In addition, a reduction in tests ordered or specimens submitted by existing customers, without
offsetting growth in its customer base, could impact the Company's ability to successfully grow its business and could have a material
adverse impact on the Company's net revenues and profitability. The Company competes primarily on the basis of the quality of testing,
timeliness of test reporting, reporting and information systems, reputation in the medical community, the pricing of services and
ability to employ qualified personnel. The Company's failure to successfully compete on any of these factors could result in the
loss of customers and a reduction in the Company's ability to expand its customer base.
In addition, as the broader healthcare industry
trend of consolidation continues, including the acquisition of physician practices by health systems, relationships with hospital-based
health systems and integrated delivery networks are becoming more important. The Company's inability to create relationships with
those provider systems and networks could impact its ability to successfully grow its business.
A failure to identify and successfully
close and integrate strategic acquisition targets could have a material adverse impact on the Company's business objectives and
its net revenues and profitability.
Part of the Company's strategy involves deploying
capital in investments that enhance the Company's business, which includes pursuing strategic acquisitions to strengthen the Company's
capabilities and increase its presence in key geographic areas. Since January 1, 2013, the Company has acquired the Hospital Assets,
clinical laboratories in California, New Jersey and New Mexico in addition to Clinlab, Medical Mime and CollabRx. However, the
Company cannot assure that it will be able to identify acquisition targets that are attractive to the Company or that are of a
large enough size to have a meaningful impact on the Company's operating results. Furthermore, the successful closing and integration
of a strategic acquisition entails numerous risks, including, among others:
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failure to obtain regulatory clearance;
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loss of key customers or employees;
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difficulty in consolidating redundant facilities and infrastructure and in standardizing information, including lack of complete integration;
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unidentified regulatory problems;
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failure to maintain the quality of services that such companies have historically provided;
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coordination of geographically-separated facilities and workforces; and
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diversion of management's attention from the present core business of the Company.
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The Company cannot assure that current or future
acquisitions, if any, or any related integration efforts will be successful, or that the Company's business will not be adversely
affected by any future acquisitions, including with respect to net revenues and profitability. Even if the Company is able to successfully
integrate the operations of businesses that it may acquire in the future, the Company may not be able to realize the benefits that
it expects from such acquisitions.
Adverse results in material litigation
matters or governmental inquiries could have a material adverse effect upon the Company's business and financial condition.
The Company may become subject in the ordinary
course of business to material legal action related to, among other things, intellectual property disputes, professional liability,
contracts and employee-related matters, as well as inquiries and requests for information from governmental agencies and bodies
and Medicare or Medicaid carriers requesting comment and/or information on allegations of billing irregularities, billing and pricing
arrangements and other matters that are brought to their attention through billing audits or third parties. The healthcare industry
is subject to substantial Federal and state government regulation and audit. Legal actions could result in substantial monetary
damages as well as damage to the Company's reputation with customers, which could have a material adverse effect upon its business.
As a company with limited capital and
human resources, we anticipate that more of management's time and attention will be diverted from our business to ensure compliance
with regulatory requirements than would be the case with a company that has well established controls and procedures. This diversion
of management's time and attention may have a material adverse effect on our business, financial condition and results of operations.
In the event we identify significant deficiencies
or material weaknesses in our internal control over financial reporting that we cannot remediate in a timely manner, or if we are
unable to receive a positive attestation from our independent registered public accounting firm with respect to our internal control
over financial reporting when we are required to do so, investors and others may lose confidence in the reliability of our financial
statements. If this occurs, the trading price of our common stock, if any, and ability to obtain any necessary equity or debt financing
could suffer. In addition, in the event that our independent registered public accounting firm is unable to rely on our internal
control over financial reporting in connection with its audit of our financial statements, and in the further event that it is
unable to devise alternative procedures in order to satisfy itself as to the material accuracy of our financial statements and
related disclosures, we may be unable to file our periodic reports with the SEC. This would likely have an adverse effect on the
trading price of our common stock, if any, and our ability to secure any necessary additional financing, and could result in the
delisting of our common stock. In such event, the liquidity of our common stock would be severely limited and the market price
of our common stock would likely decline significantly.
An inability to attract and retain experienced and qualified
personnel could adversely affect the Company's business.
The loss of key management personnel or the
inability to attract and retain experienced and qualified employees at the Company's clinical laboratories and at the hospital
could adversely affect the business. The success of the Company is dependent in part on the efforts of key members of its management
team.
In addition, the success of the Company's
clinical laboratories also depends on employing and retaining qualified and experienced laboratory professionals, including specialists,
who perform clinical laboratory testing services. The Company will also need to recruit and hire a complete staff for the hospital,
including doctors and other healthcare professionals. In the future, if competition for the services of these professionals increases,
the Company may not be able to continue to attract and retain individuals in its markets. The Company's revenues and earnings
could be adversely affected if a significant number of professionals terminate their relationship with the Company or become unable
or unwilling to continue their employment.
Failure in the Company's information
technology systems could significantly increase testing turn-around time or billing processes and otherwise disrupt the Company's
operations or customer relationships.
The Company's laboratory operations and customer
relationships depend, in part, on the continued performance of its information technology systems. Despite network security measures
and other precautions, the Company’s information technology systems are potentially vulnerable to physical or electronic
break-ins, computer viruses and similar disruptions. Sustained system failures or interruption of the Company's systems in one
or more of its laboratory operations could disrupt the Company's ability to process laboratory requisitions, perform testing, provide
test results in a timely manner and/or bill the appropriate party. Breaches with respect to protected health information could
result in violations of HIPAA and analogous state laws, and risk the imposition of significant fines and penalties. Failure of
the Company's information technology systems could adversely affect the Company's business, profitability and financial condition.
A significant deterioration in the economy
could negatively impact testing volumes, cash collections and the availability of credit.
The Company's operations are dependent upon
ongoing demand for diagnostic testing services by patients, physicians, hospitals, MCOs, and others. A significant downturn in
the economy could negatively impact the demand for diagnostic testing as well as the ability of patients and other payers to pay
for services ordered. In addition, uncertainty in the credit markets could reduce the availability of credit and impact the Company's
ability to meet its financing needs in the future.
Increasing health insurance premiums
and co-payments or high deductible health plans may cause individuals to forgo health insurance and avoid medical attention, either
of which may reduce demand for our products and services.
Health insurance premiums, co-payments and
deductibles have generally increased in recent years. These increases may cause individuals to forgo health insurance, as well
as medical attention. This behavior may reduce demand for testing by our laboratories.
Our business has substantial indebtedness.
We currently have, and will likely continue
to have, a substantial amount of indebtedness. Our indebtedness could, among other things, make it more difficult for us to satisfy
our debt and other obligations, require us to use a large portion of our cash flow from operations to repay and service our debt
or otherwise create liquidity problems, limit our flexibility to adjust to market conditions and place us at a competitive disadvantage.
As of December 31, 2016, we had total debt outstanding, excluding the effects of derivative liabilities and unamortized discounts,
of approximately $9.1 million, all of which is short term. In addition, our capital lease obligations were approximately $3.6 million
at December 31, 2016.
Our ability to meet our obligations depends
on our future performance and capital raising activities, which will be affected by financial, business, economic and other factors,
many of which are beyond our control. If our cash flow and capital resources prove inadequate to allow us to pay the principal
and interest on our debt, and meet our other obligations, we could face substantial liquidity problems and might be required to
dispose of material assets or operations, restructure or refinance our debt, which we may be unable to do on acceptable terms,
and forego attractive business opportunities. In addition, the terms of our existing or future debt agreements may restrict us
from pursuing any of these alternatives.
Failure to achieve and maintain an effective
system of internal control over financial reporting may result in our not being able to accurately report our financial results.
As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business
and the trading price of our stock.
Our management has determined that as of December
31, 2016, we did not maintain effective internal control over financial reporting based on criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework as a result
of material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination
of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement
of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. If the results
of our remediation efforts regarding our material weaknesses are not successful, or if additional material weaknesses or significant
deficiencies are identified in our internal control over financial reporting, our management will be unable to report favorably
as to the effectiveness of our internal control over financial reporting and/or our disclosure controls and procedures, and we
could be required to further implement expensive and time-consuming remedial measures and potentially lose investor confidence
in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price and potentially
subject us to litigation.
Hardware and software failures, delays
in the operation of computer and communications systems, the failure to implement system enhancements or cyber security breaches
may harm the Company.
The Company's success depends on the efficient
and uninterrupted operation of its computer and communications systems. A failure of the network or data gathering procedures could
impede the processing of data, delivery of databases and services, client orders and day-to-day management of the business and
could result in the corruption or loss of data. While certain operations have appropriate disaster recovery plans in place, we
currently do not have sufficient redundant facilities to provide IT capacity in the event of a system failure. Despite any precautions
the Company may take, damage from fire, floods, hurricanes, power loss, telecommunications failures, computer viruses, break-ins,
cybersecurity breaches and similar events at our various computer facilities could result in interruptions in the flow of data
to the servers and from the servers to clients.
In addition, any failure by the computer environment
to provide required data communications capacity could result in interruptions in service. In the event of a delay in the delivery
of data, the Company could be required to transfer data collection operations to an alternative provider of server hosting services.
Such a transfer could result in delays in the ability to deliver products and services to clients. Additionally, significant delays
in the planned delivery of system enhancements, improvements and inadequate performance of the systems once they are completed
could damage the Company's reputation and harm the business. Finally, long-term disruptions in the infrastructure caused by events
such as natural disasters, the outbreak of war, the escalation of hostilities, acts of terrorism (particularly involving cities
in which the Company has offices) and cybersecurity breaches could adversely affect the business. Although the Company carries
property and business interruption insurance, the coverage may not be adequate to compensate for all losses that may occur.
Our Chief Executive Officer is in the
process of renewing his visa to enter the United States.
Our Chief Executive Officer is Seamus
Lagan, who also acts as our interim Chief Financial Officer. In 2014, through Alcimede LLC
(of which Mr. Lagan is the sole manager) Mr. Lagan received an E2 Visa and worked at the Company’s offices in West Palm
Beach, Florida. His visa expired in late 2016. Mr. Lagan is now in the process of applying for a new E2 visa. Historical
financing activities have been completed by our CEO. No assurance can be given as to when or if his new visa will be granted,
and a continued lengthy absence of Mr. Lagan from the United States may have a material adverse effect on the Company’s
business or ability to secure additional financing.
Provisions of Delaware law and our organizational
documents may discourage takeovers and business combinations that our stockholders may consider in their best interests, which
could negatively affect our stock price.
Provisions of Delaware law and our certificate
of incorporation and bylaws may have the effect of delaying or preventing a change in control of the Company or deterring tender
offers for our common stock that other stockholders may consider in their best interests.
Our certificate of incorporation authorizes
us to issue up to 5,000,000 shares of preferred stock in one or more different series with terms to be fixed by our board of directors.
Stockholder approval is not necessary to issue preferred stock in this manner. Issuance of these shares of preferred stock could
have the effect of making it more difficult and more expensive for a person or group to acquire control of us, and could effectively
be used as an anti-takeover device.
Our bylaws provide for an advance notice procedure
for stockholders to nominate director candidates for election or to bring business before an annual meeting of stockholders, including
proposed nominations of persons for election to our board of directors, and require that special meetings of stockholders be called
only by our chairman of the board, chief executive officer, president or the board pursuant to a resolution adopted by a majority
of the board.
The anti-takeover provisions of Delaware law
and provisions in our organizational documents may prevent our stockholders from receiving the benefit from any premium to the
market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence
of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover
attempts in the future.
As a public company, we incur significant
administrative workload and expenses.
As a public company with common stock listed
on The NASDAQ Capital Market, we must comply with various laws, regulations and requirements, including certain provisions of the
Sarbanes-Oxley Act of 2002, as well as rules implemented by the SEC and The NASDAQ Stock Market. Complying with these statutes,
regulations and requirements, including our public company reporting requirements, continues to occupy a significant amount of
the time of our board of directors and management and involves significant accounting, legal and other expenses. We will need to
hire additional accounting personnel to handle these responsibilities, which will increase our operating costs. Furthermore, these
laws, regulations and requirements could make it more difficult or more costly for us to obtain certain types of insurance, including
director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the same or similar coverage. The impact of these requirements could also make it more difficult for us
to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
New laws and regulations as well as changes
to existing laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules
adopted by the SEC and by The NASDAQ Stock Market, would likely result in increased costs to us as we respond to their requirements.
We are investing resources to comply with evolving laws and regulations, and this investment may result in increased general and
administrative expenses and a diversion of management's time and attention from revenue-generating activities to compliance activities.
We do not intend to pay cash dividends
on our Common Stock in the foreseeable future.
We have never declared or paid cash dividends
on our Common Stock. We anticipate that we will retain our earnings, if any, for future growth and therefore do not anticipate
paying any cash dividends in the foreseeable future. Accordingly, our stockholders will not realize a return on their investment
unless the trading price of our Common Stock appreciates, which is uncertain and unpredictable.
We may use our stock to pay, to a large
extent, for future acquisitions or for the repayment of debt, which would be dilutive to investors.
We may choose to use additional stock to pay,
to a large extent, for future acquisitions, and believe that doing so will enable us to retain a greater percentage of our operating
capital to pay for operations and marketing. Price and volume fluctuations in our stock might negatively impact our ability to
effectively use our stock to pay for acquisitions, or could cause us to offer stock as consideration for acquisitions on terms
that are not favorable to us and our stockholders. If we did resort to issuing stock in lieu of cash for acquisitions under unfavorable
circumstances, it would result in increased dilution to investors.
Our Common Stock is subject to substantial
dilution.
The Company has outstanding options, warrants,
convertible preferred stock and convertible debt. Exercise of the options and warrants, and/or conversion of the convertible preferred
stock and debt could result in substantial dilution of our Common Stock and a decline in its market price.
The following table presents the dilutive effect
of our various potential common shares as of December 31, 2016, as adjusted for the Reverse Stock Split:
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Common shares outstanding
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2,800,377
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Dilutive potential shares:
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Stock options
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709,025
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Warrants
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1,407,647
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Convertible debt
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1,427,954
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Convertible preferred stock
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3,726,667
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Total dilutive potential
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7,271,293
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Fully diluted common shares outstanding
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10,071,670
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