| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Effective January 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers retroactively to January 1, 2016, as discussed under the Recently Adopted Accounting Pronouncements section in Note 2. All amounts and disclosures set forth in this Form 10-Q have been updated to comply with the new accounting standards, as indicated by the “as revised” notation.
The unaudited interim condensed consolidated financial information includes only adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in stockholders’ equity, and cash flows. The results of operations for the three and nine months ended September 30, 2018, are not necessarily indicative of the results for the full year or the results for any future periods. The condensed consolidated balance sheet as of December 31, 2017 has been derived from audited financial statements at that date, these financial statements should be read in conjunction with the audited financial statements, and related notes for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2018.
Liquidity Matters
The Company has incurred net losses since its inception and anticipates net losses and negative operating cash flows for the near future. For the nine months ended September 30, 2018, the Company had a net loss of $96.3 million, which increased the accumulated deficit to $542.7 million at September 30, 2018 from $446.4 million at December 31, 2017 following the full retrospective adoption of Accounting Codification Standards 606, Revenue from Contracts with Customers (“ASC 606”), which required a cumulative-effect adjustment to be recorded to the opening balance of the Company’s accumulated deficit as of January 1, 2016. At September 30, 2018, the Company had $34.5 million in cash and cash equivalents, $130.9 million in marketable securities, $50.1 million of outstanding balance of the Credit Line (as defined in Note 9) including accrued interest, and $73.3 million of net carrying amount of the 2017 Term Loan (as defined in Note 9). While the Company has introduced multiple products that are generating revenues, these revenues have not been sufficient to fund all operations. Accordingly, the Company has funded the portion of operating costs that exceeds revenues through a combination of equity issuances, debt issuances, and other financings.
The Company continues to develop and commercialize future products and, consequently, it will need to generate additional revenues to achieve future profitability and may need to raise additional equity or debt financing. If the Company raises additional funds by issuing equity securities, its stockholders would experience dilution. Additional debt financing, if available, may involve covenants restricting its operations or its ability to incur additional debt. Any additional debt financing or additional equity that the Company raises may contain terms that are not favorable to it or its stockholders and requires significant debt service payments, which diverts resources from other activities. Additional financing may not be available at all, or in amounts or on terms acceptable to the Company. If the Company is unable to obtain additional financing, it may be required to delay the development and commercialization of its products and significantly scale back its business and operations.
On July 12, 2018, the Company completed an equity offering to sell 4,500,000 shares of its common stock to the public at a price of $20 per share, along with the sale of 675,000 additional shares of its common stock to the underwriters upon their exercise of the option to purchase those shares. Upon the closing of the equity offering on July 16, 2018, the Company received proceeds of $97.3 million before offering expenses, which totaled approximately $0.5 million.
Based on the Company’s current business plan, the Company believes that its existing cash and marketable securities will be sufficient to meet its anticipated cash requirements for at least 12 months after November 8, 2018.
Principles of Consolidation
The accompanying condensed consolidated financial statements include all the accounts of the Company and its subsidiary. The Company established a subsidiary that operates in the state of Texas to support the Company’s laboratory and operational functions. All intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Significant items subject to such estimates include the allowance for doubtful accounts, contract assets and deferred revenue, accrued liability for potential refund requests, stock-based compensation, the fair value of common stock and warrants, income tax uncertainties, and the expected consideration to be received from contracts with customers. These estimates and assumptions are based on management's best estimates and judgment. Management regularly evaluates its estimates and assumptions using historical experience and other factors, including contractual terms and statutory limits; however, actual results could differ from these estimates and could have an adverse effect on the Company's financial statements.
Fair Value
The Company discloses the fair value of financial instruments for financial assets and liabilities for which the value is practicable to estimate. Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price) and the Company currently carries its warrants at fair value according to the fair value measurement guidance.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and money market deposits with financial institutions.
Restricted Cash
The Company discloses both short-term and long-term restricted cash. Short-term restricted cash consists of $4.2 million cash deposits held to secure a letter of credit associated with a settlement agreement in connection with reimbursement related claims (as described in Note 7 under Legal Proceedings ) as of September 30, 2018. Long-term restricted cash consists of $0.3 million deposit per credit card terms.
The Company adopted ASU 2016-18 effective January 1, 2018, which required the change in restricted cash to be included as part of the total cash and cash equivalents. While restricted cash is still presented as a separate line item in the Company’s balance sheet, it is no longer presented as a separate item in the statements of cash flows. ASU 2016-18 also required a restatement of the statements of cash flows in the prior period presented to report this change. The following is the reconciliation between how restricted cash is presented in the balance sheet and the statements of cash flows for all periods presented:
September 30,
December 31,
September 30,
December 31,
2018
2017
2017
2016
(in thousands)
Cash and cash equivalents in balance sheet
$
34,535
$
12,620
$
11,211
$
15,256
Restricted cash, current portion in balance sheet
4,222
59
45
1,092
Restricted cash in other assets in balance sheet
342
342
342
342
Total cash, cash equivalents and restricted cash in statements of cash flows
$
39,099
$
13,021
$
11,598
$
16,690
Investments
Investments consist primarily of debt securities such as U.S. Treasuries, U.S. agency and municipal bonds. Management determines the appropriate classification of securities at the time of purchase and re-evaluates such determination at each balance sheet date. The Company generally classifies its entire investment portfolio as available-for-sale. The Company views its available-for-sale portfolio as available for use in current operations. Accordingly, the Company classifies all investments as short-term, even though the stated maturity may be more than one year from the current balance sheet date. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), which is a separate component of stockholders’ equity.
Risk and Uncertainties
Financial instruments that potentially subject the Company to credit risk consist of cash, accounts receivable and investments. The Company limits its exposure to credit loss by placing its cash in financial institutions with high credit ratings. The Company's cash may consist of deposits held with banks that may at times exceed federally insured limits. The Company performs evaluations of the relative credit standing of these financial institutions and limits the amount of credit exposure with any one institution.
The Company bills third-party payers for certain tests performed. The amount that is ultimately received from the payer for the Company’s claim and the timing of such payments are subject to the determination of the payer based on the nature of the test performed and their view of the Company’s business practices with respect to collections of plan deductibles and co-payments from patients and other activities. This determination can impact both the amount and timing of when the Company’s invoices are collected. Payers may also withhold payments and request refunds of prior payments if the payer asserts that the Company has not performed in accordance with the policies of these payers.
The Company performs evaluations of financial conditions for insurance carriers, patients, clinics and laboratory partners and generally does not require collateral to support credit sales. For the three and nine months ended September 30, 2018 and 2017, there were no customers exceeding 10% of total revenues on an individual basis. As of September 30, 2018 and December 31, 2017, there were no customers with an outstanding balance exceeding 10% of net accounts receivable.
Revenue Recognition
The Company adopted the new revenue recognition guidance, ASC 606, beginning January 1, 2018. ASC 606 mandates revenue recognition to be evaluated using the following five steps:
·
Identification of a contract, or contracts, with a customer;
·
Identification of the performance obligations in the contract;
·
Determination of the transaction price;
·
Allocation of the transaction price to the performance obligations in the contract; and
·
Revenue recognition when, or as, the performance obligations are satisfied
See Note 3, Revenue Recognition , for detailed discussions of product revenues, licensing and other revenues, and how the five steps described above are applied.
Cost of Product Revenues
The components of cost of product revenues are material and service costs, impairment charges associated with testing equipment, personnel costs, including stock-based compensation expense, equipment and infrastructure expenses associated with testing samples, electronic medical records, order and delivery systems, shipping charges to transport samples, third-party test fees and allocated overhead including rent, information technology costs, equipment depreciation and utilities. Costs associated with the performance of diagnostic services are recorded as tests are accessioned.
Cost of Licensing and Other Revenues
The components of cost of licensing and other revenues are material costs associated with test kits, engineering costs incurred to improve and maintain the Constellation software platform, and amortization of Constellation software development costs. Costs also include collection kits consumed during the processing of cord blood samples, processing service and storage of the cord blood samples, and freight charged to transport the samples to the storage facility.
Stock‑Based Compensation
Stock‑based compensation is related to stock options and restricted stock units (“RSUs”) granted to the Company’s employees and is measured at the grant date based on the fair value of the award. The fair value is recognized as expense over the requisite service period, which is generally the vesting period of the respective awards. No compensation cost is recognized when the requisite service has not been met and the awards are therefore forfeited.
The Company uses the Black‑Scholes option‑pricing model to estimate the fair value of stock options issued to employees and non-employees. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest, and the resulting change in value, if any, is recognized in the Company's statements of operations and comprehensive loss during the period that the related services are rendered.
The Black-Scholes option-pricing model requires the input of the Company's expected stock price volatility, the expected term of the awards, and a risk-free interest rate. Determining these assumptions requires significant judgment. The expected term was the calculation of the average of—(i) the employees’ historical stock option exercise behavior and (ii) the weighted-average of the time-to-vesting and the total contractual life of the options. The volatility rate was based on that of publicly traded companies in the DNA sequencing, diagnostics, or personalized medicine industries. When selecting the public companies in these industries to be used in the volatility calculation, companies were selected with comparable characteristics to the Company, including enterprise value and financial leverage. Companies were also selected with historical share price volatility sufficient to meet the expected term of the Company's stock options. The historical volatility data was computed using the daily closing prices for the selected companies' shares during the equivalent period of the calculated expected term of the Company's stock options. The expected term of the non-employee option grants was based on their remaining contractual life at the measurement date. The risk-free interest rate assumption was based on U.S. Treasury instruments with maturities that were consistent with the option's expected term.
Warrants
The Company accounts for warrants to purchase shares of its common stock as a liability at fair value on the balance sheet date because the Company may be obligated to redeem these warrants at some point in the future. The warrants are subject to re-measurement at each balance sheet date, with changes in fair value of the warrants recognized as a gain or loss in interest and other income in the statements of operations and comprehensive loss. Further adjustments resulting from changes in fair value are no longer required as the warrants were fully exercised in June 2018.
Capitalized Software Held for Internal Use
The Company capitalizes salaries and related costs of employees and consultants who devote time to the development of internal-use software development projects. Capitalization begins during the application development stage, once the preliminary project stage has been completed. If a project constitutes an enhancement to previously developed software, the Company assesses whether the enhancement is significant and creates additional functionality to the software, thus qualifying the work incurred for capitalization. Once the project is available for general release, capitalization ceases and the Company estimates the useful life of the asset and begins amortization. The Company periodically assesses whether triggering events are present to review internal-use software for impairment. Changes in estimates related to internal-use software would increase or decrease operating expenses or amortization recorded during the reporting period. See Property and Equipment, net under Note 6 for more detail regarding an impairment charge recorded to write off certain project development costs during the first quarter of 2018.
The Company amortizes its internal-use software over the estimated useful lives of three years. The net book value of capitalized software held for internal use was $1.9 million and $2.6 million as of September, 2018 and December 31, 2017, respectively. Amortized expense for amounts previously capitalized for the three months ended September 30, 2018 and 2017 was $0.3 million and $0.3 million, respectively; and $1.0 million and $0.7 million for the nine months ended September 30, 2018 and 2017, respectively.
Accumulated Other Comprehensive Loss
Comprehensive loss and its components encompass all changes in equity other than those with stockholders, and include net loss, unrealized gains and losses on available-for-sale marketable securities.
Balance at
Balance at
December 31,
Reclassification
September 30,
2017
Increase
Adjustment
2018
(in thousands)
Unrealized (loss) gain on available-for-sale securities, net of tax
$
(766)
$
(171)
$
43
$
(894)
Total accumulated other comprehensive (loss) income, net of tax
$
(766)
$
(171)
$
43
$
(894)
Net Loss per Share
Basic net loss per share is calculated by dividing net loss by the weighted-average shares outstanding during the period, without consideration for potential dilutive shares. For purposes of the diluted net loss per share calculation, outstanding common stock options, RSUs, ESPP, and warrants are considered potential dilutive shares but are excluded from this calculation as the result becomes anti-dilutive, unless the consideration of any one of them gives a dilutive effect.
Property and Equipment
Property and equipment, including purchased and internally developed software, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which are generally three years. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the assets or the remaining term of the lease, whichever is shorter.
Impairment of Long-lived Assets
The Company periodically evaluates the carrying value of its long-lived assets for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The Company then compares the carrying amount of the long-lived assets with the future net undiscounted cash flows expected to be generated by such asset. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value determined using discounted estimates of future cash flows. See Note 6 for more detail regarding assets impairment.
Recent Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) under its accounting standard codifications (“ASC”) or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed below, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.
Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers , which amends the existing accounting standards for revenue recognition. ASU 2014-09, which defines the core principles of ASC 606, establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. ASC 606 also impacts the accounting for costs incurred in obtaining a contract with a customer, provided that such costs are considered incremental and recoverable by the Company.
Effective January 1, 2018, the Company adopted ASC 606 using the full retrospective approach. The Company revised the financial results in its statements of operations and comprehensive loss for three months ended March 31, 2017 and balance sheet as of December 31, 2017, as if ASC 606 had been effective for those periods. The adoption of ASC 606 resulted in a cumulative-effect adjustment of $41.6 million retroactively to the opening balance of accumulated deficit as of January 1, 2016. The impact of adopting the new guidance on product revenues for the three and nine months ended September 30, 2017 was a decrease of $0.7 million and an increase of $0.4 million, respectively. For financial statement disclosure purposes, the Company elected one of the practical expedients under ASC 606 to forego disclosures related to the allocation of consideration to the remaining performance obligations and the timing in which revenues will be recognized from such performance obligations.
Upon the adoption of ASC 606, the Company revised the following selected amounts in its condensed consolidated balance sheet from amounts previously reported:
December 31, 2017
As Previously
Adoption of
Reported
ASC 606
As Revised
(in thousands)
Accounts receivable, net of allowance
$
8,252
$
35,837
$
44,089
Other accrued liabilities
33,207
50
33,257
Accumulated deficit
$
(482,162)
$
35,787
$
(446,375)
Upon the adoption of ASC 606, the Company restated the following selected amounts in its unaudited condensed consolidated statements of operations and comprehensive loss from amounts previously reported:
Three months ended September 30, 2017
As Previously
Adoption of
Reported
ASC 606
As Revised
(in thousands)
Product revenues
$
55,331
$
(819)
$
54,512
Licensing and other revenues
1,325
73
1,398
Total revenues
56,656
(746)
55,910
Loss from operations
(25,043)
(746)
(25,789)
Net loss
(27,119)
(746)
(27,865)
Net loss per share:
Basic
(0.51)
(0.01)
(0.52)
Diluted
$
(0.51)
$
(0.01)
$
(0.52)
Nine months ended September 30, 2017
As Previously
Adoption of
Reported
ASC 606
As Revised
(in thousands)
Product revenues
$
153,520
$
315
$
153,835
Licensing and other revenues
3,654
86
3,740
Total revenues
157,174
401
157,575
Loss from operations
(89,111)
401
(88,710)
Net loss
(90,812)
401
(90,411)
Net loss per share:
Basic
(1.71)
0.01
(1.70)
Diluted
$
(1.71)
$
0.01
$
(1.70)
Nine months ended September 30, 2017
As Previously
Adoption of
Adoption of
Reported
ASU 2016-18
ASC 606
As Revised
(in thousands)
Operating activities:
Net loss
$
(90,812)
$
—
$
401
$
(90,411)
Changes in operating assets and liabilities:
Accounts receivable
6,147
—
(401)
5,746
Net cash used in operating activities
(68,649)
(1,047)
—
(69,696)
Cash, cash equivalents and restricted cash, beginning of period
15,256
1,434
—
16,690
Cash, cash equivalents and restricted cash, end of period
$
11,211
$
387
$
—
$
11,598
In November 2016, the FASB issued Accounting Standards Update No. 2016-18 (“ASU 2016-08”), Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). The new guidance requires restricted cash to be combined with cash and cash equivalents when reconciling the beginning and ending balances of cash on the statement of cash flows. Further, the new guidance requires the nature of the restrictions to be disclosed, as well as a reconciliation between the balance sheet and the statement of cash flows on how restricted and unrestricted cash are segregated. The Company adopted this new guidance beginning January 1, 2018 and retroactively adjusted the statements of cash flows for the nine months ended September 30, 2017 to show the combined result of cash and cash equivalents and restricted cash.
In August 2016, the FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the Emerging Issues Task Force) (“ASU 2016-15”) . The purpose of ASU 2016-15 is to limit diversity in the classification of certain transactions in the statement of cash flows. Such transactions include (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon bonds, (3) contingent consideration payments made after a business combination, (4) proceeds from insurance claims settlement, (5) proceeds from settlement of life insurance policies, and (6) distributions of equity method investments. The Company adopted this new guidance beginning January 1, 2018, which did not result in a material impact on its financial statements as none of the transactions described above occurred during the nine months ended September 30, 2018.
In May 2017, the FASB issued Accounting Standards Update No. 2017-09 (“ASU 2017-09”), Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting . The purpose of this ASU is to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted this new guidance beginning January 1, 2018, and the impact on its financial statements is not material upon adoption.
New Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. To ensure completeness of the financial statements presentation and disclosures, the Company has designated a project implementation team to perform certain procedures such as circulating lease accounting questionnaire and conducting inquiries to assess the population of the arrangements that may be considered under the scope of the new guidance. In addition, the Company is in the process of finalizing its preliminary analysis and expects the potential magnitude of its right-of-use assets and lease liabilities to be material upon the adoption of this new guidance. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements , which provides an alternative by allowing a cumulative-effect adjustment to be recorded in the opening retained earnings balance as of Jaunary 1, 2019 instead of the earliest period presented, and can be adopted concurrently with ASU 2016-02. The Company will plan on electing the alternative prescribed by ASU 2018-11 upon the adoption of ASU 2016-02 as of January 1, 2019. The modified retrospective approach must be applied to leases in existence as of the date of the adoption.
In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires measurement and recognition of expected credit losses for financial assets by requiring an allowance to be recorded as an offset to the amortized cost of such assets. For available-for-sale debt securities, expected credit losses should be estimated when the fair value of the debt securities is below their associated amortized costs. ASU 2016-13 will become effective for the Company in the first quarter of 2020, with early adoption permitted beginning the first quarter of 2019. The modified retrospective approach should be applied upon adoption of this new guidance. The Company is currently evaluating the impact of adopting ASU 2016-13 on its financial statements.
In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”) . This new guidance was established as a result of the Tax Cuts and Jobs Act passed in December 2017, which provides an opportunity for entities to reclassify residual income tax effects from accumulated other comprehensive income to retained earnings due to the reduction of the corporate income tax rate. The new guidance will be effective in the first quarter of 2019, and interim periods within that year, with early adoption permitted. The Company will have the option to apply this new guidance using either the full retrospective approach or to record the reclassifications as of the beginning date in the period of adoption. The Company is currently evaluating the impact of adopting ASU 2018-02 on its financial statements.
In June 2018, the FASB issued Accounting Standards Update No. 2018-07, Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). ASU 2018-07 is intended to reduce the cost and complexity and to improve financial reporting for nonemployee share-based payments. ASU 2018-07 expands the scope of Topic 718, Compensation-Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity-Based Payments to Non-Employees. ASU 2018-07 is effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year and early adoption is permitted. The Company is currently assessing the impact of this standard on its consolidated financial statements.
In August 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification . These amendments eliminate, modify, or integrate into other SEC requirements certain disclosure rules. Among the amendments is the requirement to present an analysis of changes in stockholders’ equity in the interim financial statements included in quarterly reports on Form 10-Q. The analysis, which can be presented as a footnote or separate statement, is required for the current and comparative quarter and year-to-date interim periods. The amendments are effective for all filings made on or after November 5, 2018. In light of the anticipated timing of effectiveness of the amendments and expected proximity of effectiveness to the filing date for most filers’ quarterly reports, the SEC’s Division of Corporate Finance issued a Compliance and Disclosure Interpretation related to Exchange Act Forms, or CDI – Question 105.09, that provides transition guidance related to this disclosure requirement. CDI – Question 105.09 states that the SEC would not object if the filer’s first presentation of the changes in shareholders’ equity is included in its Form 10-Q for the quarter that begins after the effective date of the amendments. As such, the Company adopted these SEC amendments on November 5, 2018 and will present the analysis of changes in stockholders’ equity in its interim financial statements in its March 31, 2019 Form 10-Q. The Company does not anticipate that the adoption of these SEC amendments will have a material effect on the Company’s financial position, results of operations, cash flows or shareholders’ equity. |
