EXAGEN INC. 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and financial performance, includes forward-looking statements that are based on current beliefs, plans and expectations and involve risks, uncertainties and assumptions. You should read the "Special note regarding forward-looking statements" and "Risk Factors" section of this Annual Report on Form 10-K for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Overview We are dedicated to transforming the care continuum for patients suffering from debilitating and chronic autoimmune diseases by enabling timely differential diagnosis and optimizing therapeutic intervention. We have developed and are commercializing a portfolio of innovative testing products under our AVISE ® brand, several of which are based on our proprietary CB-CAPs technology. Our goal is to enable healthcare providers to improve care for patients through the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases, including SLE and RA. Our business model of integrating testing products and therapeutics positions us to offer targeted solutions to rheumatologists and, ultimately, better serve patients. We currently market 10 testing products under our AVISE ® brand that allow for the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases. Our lead testing product, AVISE ® CTD, enables differential diagnosis for patients presenting with symptoms indicative of a wide variety of CTDs and other related diseases with overlapping symptoms. We commercially launched AVISE ® CTD in 2012 and revenue from this product comprised 81% and 70% of our revenue for the years ended December 31, 2021 and 2020, respectively. There is an unmet need for rheumatologists to add clarity in their CTD clinical evaluation, and we believe there is a significant opportunity for our tests that enable the differential diagnosis of these diseases, particularly for potentially life-threatening diseases such as SLE. We are leveraging our portfolio of testing products to establish partnerships with leading pharmaceutical companies, academic research centers and patient advocacy organizations. We also have agreements with GSK, Labcorp Drug Development and Parexel, among others, that leverage our testing products and/or the information generated from such tests. We provide GSK, a leader in lupus therapeutics, our test result data to provide market insight into and help increase awareness of the benefits of early and accurate diagnosis of SLE and lupus nephritis, and monitoring disease activity. We partner with academic research centers and patient advocacy organizations, such as Brigham and Women's Hospital, Hospital for Special Surgery, Duke University and Emory University as well as the Lupus Foundation of America, to help improve the quality of life for people affected by autoimmune diseases through programs of research, education, support and advocacy. We plan to pursue additional strategic partnerships that are synergistic with our evolving portfolio of testing products. We perform all of our AVISE ® tests in our approximately 10,000 square foot clinical laboratory, which is certified by CLIA and accredited by CAP, and located in Vista, California. Our laboratory is certified for performance of high-complexity testing by CMS in accordance with CLIA and is licensed by all states requiring out-of-state licensure. Our clinical laboratory reports all AVISE ® testing product results within five business days. In the second half of 2021, we began the conversion of approximately 8,000 square feet of warehouse space into additional clinical laboratory space and approximately 6,000 square feet of warehouse space into additional research and development facility space, and expect to complete such conversions by the first quarter of 2022 and mid 2022, respectively. The expansion of our clinical laboratory and research and development facility are expected to allow us to enhance our testing capacity and improve efficiencies as well as allow us to develop molecular and multiomic capabilities and advance our product pipeline, including support of development of tests for fibromyalgia, RA, thrombosis and lupus nephritis. We market our AVISE ® testing products using our specialized sales force. As of December 31, 2021, we have a sales force of 61 representatives covering a total of 63 territories. Unlike many diagnostic sales forces that are 75 trained only to understand the comparative benefits of their tests, the specialized backgrounds of our sales force coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified patient test reports and provide unique insights in a highly tailored discussion with rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote and sell targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and history using our portfolio of testing products. Reimbursement for our testing services comes from several sources, including commercial third-party payors, such as insurance companies and health maintenance organizations, government payors, such as Medicare, and patients. Reimbursement rates vary by product and payor. We continue to focus on expanding coverage among existing contracted rheumatologists and to achieve coverage with commercial payors, laboratory benefit managers and evidence review organizations. Since inception we have devoted substantially all of our efforts developing and marketing products for the diagnosis, prognosis and monitoring of autoimmune diseases. Although our revenue has increased sequentially year over year, we have never been profitable and, as of December 31, 2021 we had an accumulated deficit of $208.1 million. We incurred net losses of $26.9 million and $16.7 million for the years ended December 31, 2021 and 2020, respectively. We expect to continue to incur operating losses in the near term as our operating expenses will increase to support the growth of our business, as well as additional costs associated with being a public company. We have funded our operations primarily through equity and debt financings and revenue from sales of our products. We completed our initial public offering, or IPO, in September 2019, raising net proceeds from the offering of approximately $50.4 million, net of underwriting discounts, commissions and other offering expenses, for aggregate expenses of approximately $7.5 million. In March 2021, we completed a public offering of 4,255,000 shares of our common stock at a public offering price of $16.25 per share. Net proceeds from the offering were approximately $64.7 million, net of underwriting discounts and commissions and offering costs of $4.4 million. As of December 31, 2021, we had $99.4 million of cash and cash equivalents. Impact of COVID-19 The current COVID-19 worldwide pandemic has presented substantial public health challenges and is affecting our employees, patients, physicians and other healthcare providers, communities and business operations, as well as the U.S. and global economies and financial markets. International and U.S. governmental authorities in impacted regions have taken actions in an effort to slow the spread of COVID-19, including issuing varying forms of "stay-at-home" orders, restricting business functions outside of one's home, restricting gatherings, restricting travel, and mandating social distancing and face coverings. While many jurisdictions have fully reopened or have begun a phased re-opening, the potential to return to prior restrictions remain if there are future increases (or, in some jurisdictions, continued increases) in new cases of COVID-19 or any of its viral variants, including the Delta and Omicron variants. Even in areas that have fully reopened and where the number of COVID-19 cases has declined, many individuals remain cautious about resuming activities such as preventative-care medical visits. As a result of COVID-19 related limitations and reordering of priorities across the U.S. healthcare system, a reduction in patient flow occurred and our test volumes began to decrease in the second half of March 2020 and we experienced an AVISE ® CTD volume decrease of approximately 5% in the year ended December 31, 2020 as compared to 2019. In the fourth quarter of 2020, our volume of AVISE ® CTD tests delivered exceeded our pre-COVID-19 levels. For the three months ended December 31, 2021 as compared to the same period in 2020, we experienced an AVISE ® CTD volume increase of approximately 19%. For the year ended December 31, 2021 as compared to the same period in 2020, we experienced an AVISE ® CTD test volume increase of approximately 28%. However, the continued spread of COVID-19 and patient hesitancy in seeking preventative medical care, each of which are dependent on circumstances that are highly uncertain, may adversely affect testing volumes in future periods. In addition, we believe there are several other important factors that have impacted, and that we expect will impact our operating performance and results of operations, including shutdowns of our facilities and operations as well as those of our suppliers and courier services, disruptions to the supply chain of material needed for our tests, our sales and commercialization activities and our ability to receive specimens and perform or deliver the results from our tests, delays in reimbursement and coverage decisions from Medicare and third-party payors and in interactions with regulatory authorities, as well as our inability to achieve volume-based pricing discounts with our key suppliers and absorb fixed laboratory expenses. For example, we have experienced delays in patient enrollment for ongoing and planned clinical studies involving our tests, which may delay or prevent launch of future test products. We have also experienced delays, beginning in the first quarter of 2021, in procurement of our testing supplies due in part to disruptions to the global supply chain resulting from the COVID-19 pandemic, which may continue into the future, and our partners, may also experience a disruption in their ability to readily obtain supply. Our sales force has been, 76 and for an extended period of time may continue to be limited, in their in-person interactions with healthcare providers, and therefore, also limited in their ability to engage in various types of healthcare provider education activities. Healthcare providers and patients have canceled or delayed scheduling, and for an extended period of time may continue to cancel or delay scheduling, standard wellness visits and other non-emergency appointments and procedures, contributing to a decline in orders of our testing products. The portion of our workforce which has been working remotely in an effort to reduce the spread of COVID-19, may be infected from the virus or otherwise distracted. We are facing and may continue to face increased competition for laboratory and scientific employees due to the increased demand in the industry for such personnel. We may inaccurately estimate the duration or severity of the COVID-19 pandemic, which could cause us to misalign our staffing, spending, activities and precautionary measures with market current or future market conditions. In response to the COVID-19 pandemic, we initially curtailed non-essential travel and have equipped most of our employees with the ability to work remotely with the exception of our clinical laboratory employees, and implemented measures to protect the health of our employees and to support the functionality of our clinical laboratory, such as providing personal protective equipment (including face masks or shields) and maintaining social distancing. In addition, in the second quarter of 2020, our sales force recommenced certain field-based interactions and scaled marketing spend, although access to healthcare providers remains limited and the use of virtual sales tools has increased. From March 2020 through December 31, 2020, as a result of the COVID-19 pandemic, we terminated our temporary employees and 18 full-time employees, which included three employees at the vice president level. During 2021, we returned to normalized personnel levels. The full extent of which the COVID-19 pandemic will directly or indirectly continue to impact our business, results of operations and financial condition and will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain it or treat COVID-19, including success of ongoing vaccination efforts, the emergence and prevalence of variant strains of COVID-19, the institution or reinstitution of shutdowns, "stay-at-home-orders" and other public health measures, as well as the related economic impact of these matters on local, regional and international markets. Factors Affecting Our Performance In addition to the impact of COVID-19, we believe there are several important factors that have impacted, and that we expect will impact, our operating performance and results of operations, including: ▪ Continued Adoption of Our Testing Products. Since the launch of AVISE ® CTD in 2012 and through December 31, 2021, we have delivered over 615,000 of these tests. For the year ended December 31, 2021, 128,246 AVISE ® CTD tests were delivered, representing approximately 28% growth over the same period in 2020. In the fourth quarter of 2021, the number of ordering healthcare providers reached a record 2,126, representing an approximate 26% increase over the same period in 2020, and we had a record 739 adopting healthcare providers (defined as those who previously prescribed at least 11 diagnostic tests in the corresponding period) compared to 635 in the same period in 2020. A high percentage of adopting healthcare providers continue to order tests in subsequent quarters, as approximately 99% of adopting healthcare providers from the third quarter of 2021 ordered at least one diagnostic test in the fourth quarter of 2021. Revenue growth for our testing products will depend on our ability to continue to expand our base of ordering healthcare providers and increase our penetration with existing healthcare providers. ▪ Reimbursement for Our Testing Products . Our revenue depends on achieving broad coverage and reimbursement for our tests from third-party payors, including both commercial and government payors such as Medicare. Payment from third-party payors differs depending on whether we have entered into a contract with the payors as a "participating provider" or do not have a contract and are considered a "non-participating provider." Payors will often reimburse non-participating providers, if at all, at a lower amount than participating providers. We have received a substantial portion of our revenue from a limited number of third-party commercial payors, most of which have not contracted with us to be a participating provider. Historically, we have experienced situations where commercial payors proactively reduced the amounts they were willing to reimburse for our tests, and in other situations, commercial payors have determined that the amounts they previously paid were too high and have sought to recover those perceived excess payments by deducting such amounts from payments otherwise being made. When we contract to serve as a participating provider, reimbursements are made pursuant to a negotiated fee schedule and are limited to only covered indications. If we are not able to obtain or maintain coverage and adequate reimbursement from third-party payors, we may not be able to effectively increase our testing volume and revenue as 77 expected. Additionally, retrospective reimbursement adjustments can negatively impact our revenue and cause our financial results to fluctuate. ▪ Synergistic Partnerships . In August 2021, we mutually agreed to terminate the Janssen Agreement regarding our promotion efforts with SIMPONI ® effective August 31, 2021. Our SIMPONI ® promotion efforts contributed approximately $1.2 million and $5.1 million in revenue for the years ended December 31, 2021 and 2020, respectively. We will continue to rely on our existing testing products to drive revenue growth. ▪ Development of Additional Testing Products. We rely on sales of our AVISE ® CTD test to generate the significant majority of our revenue. We expect to continue to invest in research and development in order to develop additional testing products and expect these costs to increase. Our success in developing new testing products will be important in our efforts to grow our business by expanding the potential market for our testing products and diversifying our sources of revenue. ▪ Maintain Meaningful Margin . We believe we are well positioned to maintain meaningful margin through a continued focus on increasing operating leverage through the implementation of certain internal initiatives, such as conducting additional validation and reimbursement oriented clinical studies to facilitate payor coverage of our testing products, capitalizing on our growing reagent purchasing to negotiate improved volume-based pricing and automation in our clinical laboratory to reduce material and labor costs. ▪ Timing of Our Research and Development Expenses . Our spending on experiments and clinical studies may vary substantially from quarter to quarter. We also expend funds to secure clinical samples that can be used in discovery, product development, clinical validation, utility and outcome studies. The timing of these research and development activities is difficult to predict. If a substantial number of clinical samples are obtained in a given quarter or if a high-cost experiment is conducted in one quarter versus the next, the timing of these expenses will affect our financial results. We conduct clinical studies to validate our new testing products, as well as ongoing clinical and outcome studies to further expand the published evidence to support our commercialized AVISE ® testing products. Spending on research and development for both experiments and studies may vary significantly by quarter depending on the timing of these various expenses. ▪ How We Recognize Revenue . We record revenue on an accrual basis based on our estimate of the amount that will be ultimately realized for each test upon delivery based on a historical analysis of amounts collected by test and by payor. Changes to such estimates may increase or decrease revenue recognized in future periods. While each of these areas present significant opportunities for us, they also pose significant risks and challenges that we must address. We discuss many of these risks, uncertainties and other factors in the section entitled "Risk Factors." Janssen Promotion Agreement In December 2018, we entered into the Janssen Agreement, under which we were responsible for the costs associated with our sales force in promoting SIMPONI ® in the United States. In August 2021, we and Janssen mutually agreed to terminate the Janssen Agreement effective August 31, 2021. Pursuant to the Janssen Agreement, Janssen was responsible for all other costs associated with our promotion of SIMPONI ® under the Janssen Agreement. In exchange for our sales and co-promotional services, we were entitled to a quarterly tiered promotion fee based on the incremental increase in total prescribed units of SIMPONI ® for that quarter over a predetermined baseline. For the year ended December 31, 2020, the tiered promotion fee ranged from $750 to $1,250 per prescription over a predetermined baseline. Due in part to COVID-19, in June 2020 we amended the Janssen Agreement, to adjust the predetermined average baseline for the third and fourth quarters of 2020. In December 2020, we further amended the Janssen Agreement, to adjust the average baseline for total prescribed units of SIMPONI ® for the quarters ending December 31, 2020, March 31, 2021, subject to further adjustment under certain circumstances. In June 2021, the Janssen Agreement was again amended to proportionally increase the baseline for prescribed units for the quarter ending June 30, 2021 to reflect the addition of certain geographies to the sales territories covered by the Janssen Agreement. For the first and second quarters of 2021, we earned the minimum promotion fee of $0.3 million. Upon termination of the Janssen Agreement on August 31, 2021, we became entitled to receive an aggregate $0.6 million in consideration, which was earned in the year ended December 31, 2021. Pursuant to the terms of the termination, we are restricted from promoting any other biologic or Janus kinase inhibitor used for treatment of indications covered by the Janssen Agreement without first obtaining Janssen's written consent until May 31, 2022. 78 We recognized approximately $1.2 million and $5.1 million in revenue for the years ended December 31, 2021 and 2020, respectively, for our promotional efforts under the Janssen Agreement. Seasonality Based on our experience to date, we expect some seasonal variations in our financial results due to a variety of factors, such as the year-end holiday period and other major holidays, vacation patterns of both patients and healthcare providers, including medical conferences, climate and weather conditions in our markets (for example excess sun exposure can cause flares in SLE), seasonal conditions that may affect medical practices and provider activity, including for example influenza outbreaks that may reduce the percentage of patients that can be seen, and other factors relating to the timing of patient benefit changes, as well as patient deductibles and co-insurance limits. Financial Overview Revenue To date, we have derived nearly all of our revenue from the sale of our testing products, most of which is attributable to our AVISE ® CTD test. We primarily market our testing products to rheumatologists in the United States. The rheumatologists who order our testing products and to whom results are reported are generally not responsible for payment for these products. The parties that pay for these services, or payors, consist of healthcare insurers, government payors (primarily Medicare and Medicaid), client payors (e.g. hospitals, other laboratories, etc.), and patient self-pay. Our service is completed upon the delivery of test results to the prescribing rheumatologists which triggers billing for the service. We recognize revenue in accordance with the provisions of ASC Topic 606, Revenue from Contracts with Customers. We record revenue on an accrual basis based on our estimate of the amount that will be ultimately realized for each test upon delivery based on a historical analysis of amounts collected by test and by payor. These assessments require significant judgment by management. Our ability to increase our revenue will depend on our ability to further penetrate the market for our current and future testing products, and increase our reimbursement and collection rates for tests delivered. As discussed above, our volume of AVISE ® CTD tests delivered substantially recovered to pre-COVID-19 levels in the fourth quarter of 2020. However, the continued spread of COVID-19, including any of its viral variants, may adversely affect testing volumes in future periods, and the extent of any such adverse effects is highly uncertain. Operating Expenses Costs of Revenue Costs of revenue represents the expenses associated with obtaining and testing patient specimens. The components of our costs of revenue include materials costs, direct labor, equipment and infrastructure expenses associated with testing specimens, shipping charges to transport specimens, blood specimen collections fees, royalties, depreciation and allocated overhead, including rent and utilities. Each payor, whether a commercial third-party, government, or individual, reimburses us at different amounts. These differences can be significant. As a result, our costs of revenue as a percentage of revenue may vary significantly from period to period due to the composition of payors for each period's billings. Assuming future testing volumes are not negatively impacted by the continued spread of COVID-19, we expect that our costs of revenue will increase in absolute dollars as the number of tests we perform increases. However, we expect that the cost per test will decrease over time due to volume discounts on materials and other volume efficiencies we may gain as the number of tests we perform increases. The decrease in cost per test may be partially offset due to increased depreciation and allocated overhead associated with our clinical laboratory expansion as well as increased labor, material and shipping costs (including as a result of inflation) associated with the commercialization of our portfolio products. As discussed above, the continued spread of COVID-19 may adversely affect testing volumes which may result in an increase in cost per test due to our inability to realize volume efficiencies. Selling, General and Administrative Expenses 79 Selling, general and administrative expenses consist of personnel costs, including stock-based compensation expense, direct marketing expenses, accounting and legal expenses, consulting costs, and allocated overhead including rent, information technology, depreciation and utilities. We expect that our selling, general and administrative expenses will increase in absolute dollars in 2022 as compared to 2021, due to expected additions to headcount and associated increases for personnel costs, including stock-based compensation. Research and Development Expenses Research and development expenses include costs incurred to develop our technology, testing products and product candidates, collect clinical specimens and conduct clinical studies to develop and support our testing products and product candidates. These costs consist of personnel costs, including stock-based compensation expense, materials, laboratory supplies, consulting costs, costs associated with setting up and conducting clinical studies and allocated overhead including rent and utilities. We expense all research and development costs in the periods in which they are incurred. We expect that our research and development expenses will increase in absolute dollars in 2022 as compared to 2021, as we continue to invest in research and development activities related to our existing testing products and product candidates, including the expansion of our clinical research and development facility, expected additions to headcount and associated increases for personnel costs, including stock-based compensation. Interest Expense Interest expense consists of cash and non-cash interest expense associated with our financing arrangements, including the borrowings under our amended loan and security agreement with Innovatus Life Sciences Lending Fund I, LP, or Innovatus. We expect interest expense to decrease in the near term due to lower interest rates related to our amended loan and security agreement with Innovatus. Other Income, Net Other income, net, consists primarily of interest income earned on our cash and cash equivalents and an amount received under the CARES Act Provider Relief Fund in the second quarter of 2020. Income Tax (Expense) Benefit Income taxes include federal and state income taxes in the United States. Results of Operations 80 Comparison of the Years Ended December 31, 2021 and 2020: Years Ended December 31, Change 2021 2020 (in thousands) Revenue $ 48,299 $ 41,975 $ 6,324 Operating expenses: Costs of revenue 20,588 16,559 4,029 Selling, general and administrative expenses 44,541 37,033 7,508 Research and development expenses 7,237 3,568 3,669 Total operating expenses 72,366 57,160 15,206 Loss from operations (24,067) (15,185) (8,882) Interest expense (2,625) (2,565) (60) Other income, net 16 984 (968) Loss before income taxes (26,676) (16,766) (9,910) Income tax (expense) benefit (175) 79 (254) Net loss $ (26,851) $ (16,687) $ (10,164) Revenue Revenue increased $6.3 million, or 15.1%, for the year ended December 31, 2021 compared to the year ended December 31, 2020, primarily due to an increase in the number of diagnostic tests delivered resulting in part from volume reductions experienced in late March 2020 as a result of the COVID-19 pandemic. The number of AVISE ® CTD tests delivered, which accounted for 81% and 70% of revenue for the years ended December 31, 2021 and 2020, respectively, increased to 128,246 tests delivered in the year ended December 31, 2021 compared to 100,450 tests delivered in the same 2020 period. The number of AVISE ® CTD tests increased to 34,147 for the three months ended December 31, 2021 compared to 28,601 tests delivered in the same 2020 period. The number of ordering healthcare providers increased to 2,126 for the three months ended December 31, 2021 compared to 1,690 in the same 2020 period. The increase in revenue was partially offset by a decrease in revenue resulting from the Janssen Agreement during the year ended December 31, 2021 to approximately $1.2 million compared to approximately $5.1 million for the year ended December 31, 2020. Costs of Revenue Costs of revenue increased $4.0 million, or 24.3%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to increased direct costs such as materials and supplies, labor and shipping and handling associated with the increase in test volume in 2021 compared to 2020, partially offset by decreased royalty costs. Gross margin as a percentage of revenue decreased to 57.4% for the year ended December 31, 2021, compared to 60.6% for the year ended December 31, 2020. This was primarily attributable to a decrease in revenue resulting from the Janssen Agreement. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $7.5 million, or 20.3%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to an increase of $5.7 million of employee related expenses, including stock-based compensation and recruitment expenses, increases related to insurance expenses of $0.5 million, marketing expenses of $0.5 million and audit and professional services of $0.2 million. The first quarter of 2020 included one-time restructuring charges of approximately $0.2 million. Research and Development Expenses Research and development expenses increased $3.7 million, or 102.8%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The increase was primarily due to an increase of $1.2 million of employee related expenses, including stock-based compensation and recruitment expenses, and increases related 81 to clinical study expenses of $0.9 million, license fees of $0.8 million, laboratory supplies expense of $0.3 million and collaboration expenses of $0.3 million. Interest Expense Interest expense remained substantially consistent for the year ended December 31, 2021 compared to the year ended December 31, 2020. Other Income, Net Other income, net, decreased $1.0 million for the year ended December 31, 2021 compared to the year ended December 31, 2020. This decrease was primarily driven by the $0.7 million we received under the CARES Act Provider Relief Fund due to lost revenues attributable to COVID-19 in the second quarter of 2020 and lower money market interest rates in 2021 compared to 2020. Income Tax (Expense) Benefit Income tax expense increased $0.3 million for the year ended December 31, 2021 compared to the year ended December 31, 2020 due to an expiration of benefits under the CARES Act. Liquidity and Capital Resources We have incurred net losses since our inception. For the years ended December 31, 2021 and 2020, we incurred a net loss of $26.9 million and $16.7 million, respectively, and we expect to incur additional losses and increased operating expenses in future periods. As of December 31, 2021, we had an accumulated deficit of $208.1 million. To date, we have generated only limited revenue, and we may never achieve revenue sufficient to offset our expenses. Our primary sources of capital have primarily been sales of our common stock and redeemable convertible preferred stock, the sale of our common stock of our IPO, and, to a lesser extent, borrowings under various debt financings. On November 10, 2020, we filed a registration statement on Form S-3, or the Shelf Registration Statement, covering the offering, from time to time, of up to $150.0 million of common stock, preferred stock, debt securities, warrants and units, which Shelf Registration Statement became effective on November 19, 2020. In March 2021, we completed a public offering of 4,255,000 shares of our common stock at a public offering price of $16.25 per share, which shares were sold under the Shelf Registration Statement. Net proceeds from the offering were approximately $64.7 million, net of underwriting discounts and commissions and other offering expenses of $4.4 million. As of December 31, 2021, we had $99.4 million of cash and cash equivalents. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. Currently, our funds are held in cash and money market funds. In September 2017, we entered into the loan and security agreement with Innovatus under which we immediately drew down $20.0 million. In December 2018, we borrowed an additional $5.0 million under the loan agreement. In each of November 2019 and November 2021, we amended the loan and security agreement with Innovatus, which we collectively refer to as the Amended Loan Agreement. Pursuant to the Amended Loan Agreement, the loan term is for nine years with a final maturity date of November 2026. The Amended Loan Agreement accrues interest at an annual rate of 8.0%, of which 2.0% will be payable in-kind. Paid in-kind interest is added to the principal balance each period. After December 1, 2024, the entire 8.0% will be paid in cash at the end of each period. On or after November 1, 2022, we may, at our option, prepay the term loan borrowings by paying the lender a prepayment premium. The prepayment premium was 3% as of November 2021 and decreases by 1% on each of November 1, 2022, November 1, 2023 and November 1, 2024. Our obligations under the Amended Loan Agreement are secured by a security interest in substantially all of our assets, including our intellectual property. The Amended Loan Agreement contains customary conditions to borrowing, events of default, and covenants, including covenants requiring us to maintain certain levels of minimum liquidity of $2.0 million, performance covenants to achieve certain minimum amounts of revenue, and covenants limiting our ability to dispose of assets, undergo a change in control, merge with or acquire other entities, incur debt, incur liens, pay dividends or other distributions to holders of our capital stock, repurchase stock and make investments, in each case subject to certain exceptions. The consequences of failing to achieve the performance covenant will be cured if, within sixty days of failing to achieve the performance covenant, we issue additional equity securities or subordinated debt with net proceeds sufficient to fund any cash flow deficiency generated from operations, as defined in the Amended Loan Agreement. At December 31, 2021, we were in compliance with all 82 covenants of the Amended Loan Agreement. In addition, upon the occurrence of an event of default, Innovatus, among other things, can declare all indebtedness due and payable immediately, which would adversely impact our liquidity and reduce the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes. In April 2020, we received $0.7 million of funding under the CARES Act Provider Relief Fund, subject to our agreement to comply with the Department of Health & Human Services', or HHS, standard terms and conditions. The CARES Act Provider Relief Fund is a federal fund allocated for general distributions to Medicare facilities and providers impacted by the COVID-19 pandemic and is intended to support healthcare-related expenses or lost revenue attributable to COVID-19. Funding Requirements Our primary uses of cash are to fund our operations as we continue to grow our business. We expect to continue to incur operating losses in the near term as our operating expenses will be increased to support the growth of our business. We expect that our costs of revenue, selling, general and administrative expenses, and research and development expenses will continue to increase as we increase our test volume, expand our marketing efforts and increase our internal sales force to drive increased adoption of and reimbursement for our AVISE ® testing products, prepare to commercialize new testing products, continue our research and development efforts and further develop our product pipeline. We believe we have sufficient laboratory capacity to support increased test volume. We expect to make significant investments for laboratory equipment and capital expenditures in the near term related to our laboratory facilities and expansion of research capabilities, including an investment to convert approximately 8,000 square feet of warehouse space into additional clinical laboratory space and approximately 6,000 square feet of warehouse space into additional research and development facility space. We began such conversion in the second half of 2021 and expect to complete the conversion for the clinical laboratory space by the first quarter of 2022 and expect to complete the conversion for the additional research and development facility by mid 2022. The expansion of our clinical laboratory and research and development facility are expected to allow us to enhance our testing capacity and improve efficiencies as well as allow us to develop molecular and multiomic capabilities and advance our product pipeline, including support of the development of tests for fibromyalgia, RA, thrombosis and lupus nephritis. Cash used to fund operating expenses is impacted by the timing of when we pay expenses, as reflected in the change in our outstanding accounts payable and accrued expenses. We expect that our near- and longer-term liquidity requirements will continue to consist of working capital and general corporate expenses associated with the growth of our business, including payments we may be required to make upon the achievement of previously negotiated milestones associated with intellectual property we have licensed, payments related to non-cancelable purchase obligations with one supplier for reagents, payments related to our principal and interest under our long term borrowing arrangements, payments for operating leases related to our office and laboratory space in Vista, California and our office space in Carlsbad, California, and payments for capital leases related to our laboratory equipment (see Note 4 and Note 5 in the audited financial statements included in this Annual Report on Form 10-K). Based on our current business plan, we believe that our existing cash and cash equivalents and our anticipated future revenue, will be sufficient to meet our anticipated cash requirements for at least the next 12 months from the date of this filing. Our estimate of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including: • the impact of the COVID-19 pandemic on our business, including challenges resulting from social distancing and stay-at-home orders through a reduction in testing volumes; • our ability to maintain and grow sales of our AVISE ® testing products, as well as the costs associated with conducting clinical studies to demonstrate the utility of our products and support reimbursement efforts; ▪ our ability to achieve sufficient market acceptance, coverage and adequate reimbursement from third-party payors and adequate market share and revenue for our testing products; ▪ fluctuations in working capital; ▪ the costs of developing our product pipeline, including the costs associated with conducting our ongoing and future validation, utility and outcome studies as well as the success of our development efforts; ▪ the additional costs we may incur as a result of operating as a public company; ▪ the extent to which we establish additional partnerships or in-license, acquire or invest in complementary businesses or products as well as the success of our existing partnerships and/or in-licenses; and 83 ▪ the costs associated with our promotion of other therapeutics, if any, including the expansion of our sales capabilities, and the extent and timing of generating revenue from each such promotion, if any. Until such time, if ever, as we can generate revenue to support our costs structure, we expect to finance our operations through equity offerings, debt financings or other capital sources, including potentially collaborations, licenses and other similar arrangements. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders may be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. If additional funding is required or desired, there can be no assurance that additional funds will be available to us on acceptable terms on a timely basis, if at all, or that we will generate sufficient cash from operations to adequately fund our operating needs or achieve or sustain profitability. If we are unable to raise additional capital or generate sufficient cash from operations to adequately fund our operations, we will need to delay, reduce or eliminate some or all of our research and development programs, product portfolio expansion plans or commercialization efforts. Doing so will likely have an unfavorable effect on our ability to execute on our business plan and could have a negative impact on our commercial and strategic relationships. If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition, and results of operations could be adversely affected. Cash Flows The following table summarizes our cash flows for the periods indicated: Years Ended December 31, 2021 2020 (in thousands) Net cash provided by (used in): Operating activities $ (20,269) $ (14,084) Investing activities (2,420) (455) Financing activities 64,683 (97) Net change in cash, cash equivalents and restricted cash $ 41,994 $ (14,636) Cash Flows from Operating Activities Net cash used in operating activities for the year ended December 31, 2021 was $20.3 million and primarily resulted from (i) our net loss of $26.9 million adjusted for non-cash charges of $6.6 million related to stock-based compensation, depreciation, amortization, non-cash interest and deferred income taxes and (ii) changes in our net operating assets of $0.1 million primarily related to net increases in accounts receivable, net and net decreases in accounts payable, partially offset by net decreases in prepaid expenses and other current assets and net increases in accrued liabilities and other current liabilities. Net cash used in operating activities for the year ended December 31, 2020 was $14.1 million and primarily resulted from (i) our net loss of $16.7 million adjusted for non-cash charges of $3.9 million related to stock-based compensation, non-cash interest, depreciation, amortization and deferred income taxes and (ii) changes in our net operating assets of $1.3 million related to net increases in accounts receivables and prepaid expenses and other current assets, partially offset by net increases in accounts payable and accrued liabilities and other current liabilities. Cash Flows from Investing Activities Net cash used in investing activities for the year ended December 31, 2021 and 2020 was $2.4 million and $0.5 million, respectively, and was primarily due to net purchases of property and equipment. Cash Flows from Financing Activities Net cash provided by financing activities for the year ended December 31, 2021 was $64.7 million and primarily resulted from the net proceeds received from our public offering in March 2021 of $64.7 million and proceeds from the Exagen Inc. 2019 Employee Stock Purchase Plan, or the ESPP, purchases, partially offset by principal payments on capital lease obligations. 84 Net cash used in financing activities for the year ended December 31, 2020 was $0.1 million and primarily resulted from principal payments on capital lease obligations, as well as proceeds from our unsecured loan pursuant to the U.S. Small Business Administration Paycheck Protection Program under the CARES Act, which we subsequently repaid in May 2020, partially offset by proceeds from ESPP purchases. Critical Accounting Policies and Significant Management Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our audited financial statements, which have been prepared in accordance with accounting principles generally accepted in United States of America, or GAAP. The preparation of these audited financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the audited financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgement and estimates. Revenue Recognition To date, substantially all of our revenue has been derived from sales of our testing products. We primarily market our testing products to rheumatologists and their physician assistants in the United States. The healthcare professionals who order our services and to whom test results are reported are generally not responsible for payment for these services. The parties that pay for these services consist of healthcare insurers, government payors (primarily Medicare and Medicaid), client payors (e.g. hospitals, other laboratories, etc.) and patient self-pays. Payors are billed at our list price. Net revenues recognized consist of amounts billed net of allowances for differences between amounts billed and the estimated consideration we expect to receive from such payors. We follow a standard process, which considers historical denial and collection experience, insurance reimbursement policies and other factors, to estimate allowances and implicit price concessions, recording adjustments in the current period as changes in estimates. Further adjustments to the allowances, based on actual receipts, is recorded upon settlement. The transaction price is estimated using an expected value method on a portfolio basis. Our portfolios are grouped per payor (e.g. each individual third-party insurance, Medicare, client payors, patient self-pay, etc.) and per test basis. Collection of our net revenues from payors is normally a function of providing complete and correct billing information to the healthcare insurers and generally occurs within 30 to 90 days of billing. The process for estimating revenues and the ultimate collection of accounts receivable involves significant judgment and estimation by management. We continually assess the state of our cash collections in order to identify areas of risk and opportunity that allow us to appropriately estimate receivables and revenue. Should we later determine the judgements underlying estimated collections change, our financial results could be impacted in future periods. Revenue recognized during the years ended December 31, 2021 and 2020 related to performance obligations satisfied in prior periods was approximately $0.7 million and $0.8 million, respectively, which relates to a change in estimate of the transaction price. In December 2018, we entered into the Janssen Agreement to co-promote SIMPONI ® in the United States. Our obligations relating to sales and co-promotion services for SIMPONI ® were a series of single performance obligations since Janssen simultaneously received and consumed the benefits provided by our sales and co-promotional services. The method for measuring progress towards satisfying the performance obligations is based on prescribed units in excess of the contractual baseline at the contractual rate earned per unit since the agreement was cancelable. In August 2021, we and Janssen mutually agreed to terminate the Janssen Agreement effective August 31, 2021. Long-Lived Assets 85 Our long-lived assets are comprised principally of our property and equipment, finite lived intangible assets, and goodwill. We amortize all finite lived intangible assets over their respective estimated useful lives. In considering whether intangible assets are impaired, we combine our intangible assets and other long-lived assets (excluding goodwill), into groupings, a determination which we principally make on the basis of whether the assets are specific to a particular test offered by us or technology we are developing. If we identify events or circumstances indicate that the associated carrying amount of assets within a group may not be recoverable, we will consider the assets in the group impaired if the carrying value of the group’s assets and directly associated liabilities exceed the estimated cash flows expected to be generated over the estimated useful life of the assets in the group. Management’s estimates of future cash flows are impacted by projected levels of tests and levels of reimbursement, as well as expectations related to the future cost structure of the entity. Goodwill is not amortized but is tested for impairment at least annually or more frequently whenever a triggering event or change in circumstances occurs, at the reporting unit level. For our goodwill impairment analysis, we operate in a single reporting unit, and allocate all goodwill to this reporting unit. We are required to recognize an impairment charge if the carrying amount of the reporting unit exceeds its fair value. Management first assesses qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than the carrying amount as a basis for determining whether it is necessary to perform a quantitative assessment. If a quantitative assessment is deemed necessary, management uses all available information to make this fair value determination, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets and observed market multiples of operating cash flows. The judgments and estimates involved in identifying and quantifying the impairment of long-lived assets or goodwill involve inherent uncertainties, and the measurement of the fair value is dependent on the accuracy of the assumptions used in making the estimates and how those estimates compare to our future operating performance. No goodwill impairments were recorded during the years ended December 31, 2021 and 2020. Following the completion of our IPO in September 2019, our stock price and associated market capitalization will also be considered in the determination of reporting unit fair value. A prolonged or significant decline in our share price could provide evidence of a need to record a material impairment to goodwill. Stock-Based Compensation We recognize compensation expense related to stock-based awards to employees and directors based on the estimated fair value of the awards on the date of grant over the requisite service period of the awards (usually the vesting period) on a straight-line basis. The grant date fair value, and the resulting stock-based compensation expense, is estimated using the Black-Scholes option pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the vesting period of the respective award. We recorded stock-based compensation expense of approximately $4.7 million and $2.7 million for the years ended December 31, 2021 and 2020, respectively. We expect to continue to grant stock options and other equity-based awards in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase. The Black-Scholes option pricing model requires the use of highly subjective and complex assumptions, which determine the fair value of stock-based awards. If we had made different assumptions, our stock-based compensation expense, net loss and net loss per share attributable to common stockholders could have been significantly different. See Notes 2 and 8 to our audited financial statements included elsewhere in this Annual Report on Form 10-K for information concerning certain of the specific assumptions we used in applying the Black-Scholes option pricing model to determine the estimated fair value of our stock options granted and purchases under our ESPP rights in the years ended December 31, 2021 and 2020. Determination of the Fair Value of Our Common Stock Following the closing of our initial public offering, our board of directors determines the fair value of our common stock based on its closing price as reported on the date of grant on the primary stock exchange on which our common stock is traded. Income Taxes 86 We operate in, and are subject to tax authorities in, various tax jurisdictions in the United States. To date, we have not been audited by the Internal Revenue Service or any state income tax authority. All tax years remain open for examination by federal and state tax authorities. At December 31, 2021, our deferred tax assets are primarily comprised of federal and state tax NOL carryforwards. We previously completed a study to assess whether an ownership change, as defined by Section 382 of the Code, had occurred from our formation through December 31, 2019. Based upon this study, we determined that ownership changes had occurred in 2003, 2008, 2012, 2017 and 2019, and that our ability to use a significant portion of our NOL carryforwards is subject to limitation under Section 382 of the Code as a result of a prior ownership change. In addition, federal NOL carryforwards generated in periods after December 31, 2017, may be carried forward indefinitely but, in taxable years beginning after December 31, 2020, may only be used to offset 80% of our taxable income. We are required to reduce our deferred tax assets by a valuation allowance if it is more likely than not that some or all of our deferred tax assets will not be realized. We must use judgment in assessing the potential need for a valuation allowance, which requires an evaluation of both negative and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. In determining the need for and amount of our valuation allowance, if any, we assess the likelihood that we will be able to recover our deferred tax assets using historical levels of income, estimates of future income and tax planning strategies. As a result of historical cumulative losses and uncertainties surrounding our ability to generate future taxable income and, based on all available evidence, we believe it is more likely than not that our recorded net deferred tax assets will not be realized. Accordingly, we have recorded a valuation allowance against all of our net deferred tax assets at December 31, 2021. We will continue to maintain a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of this allowance. The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Please see our audited financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K, which contain accounting policies and other disclosures required by GAAP. Recent Accounting Pronouncements See "Notes to the Financial Statements-Note 2-Recent Accounting Pronouncements" of our annual financial statements. JOBS Act Accounting Election The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an "emerging growth company." The JOBS Act permits an "emerging growth company" such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to use this extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our audited financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. We will remain an emerging growth company until the last day of our fiscal year following the fifth anniversary of the date of the first sale of our common equity securities pursuant to an effective registration statement under the Securities Act, which will occur in 2024. However, if certain events occur prior to the end of this five-year period, including if we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act, our annual gross revenues exceed $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to this anniversary. 87 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Not applicable. Item 8. Financial Statements and Supplementary Data. The financial statements and supplemental data required by this item are set forth at the pages indicated in Part IV, Item 15(a)(1) of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.