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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ________________________________ 

FORM 10-Q
  ________________________________ 
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020 
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            
 
Commission file number 001-36156
 ________________________________ 

VERACYTE, INC.
(Exact name of registrant as specified in its charter)
________________________________ 
 
Delaware 20-5455398
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
 
6000 Shoreline Court, Suite 300
South San Francisco, California 94080
(Address of principal executive offices, zip code)
 
(650243-6300
(Registrant’s telephone number, including area code)
  ________________________________ 


Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value, $0.001 per share
VCYT
The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company 
Emerging growth company 


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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes No ý

As of April 30, 2020, there were 50,053,437 shares of common stock, par value $0.001 per share, outstanding.


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VERACYTE, INC.
INDEX
 
 Page
No.
 
 

i

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PART I. — FINANCIAL INFORMATION
 
Item 1. Condensed Financial Statements
 
VERACYTE, INC. 

Condensed Consolidated Balance Sheets 

(unaudited)

(In thousands, except share and per share amounts)
 March 31,
2020
December 31, 2019
 (See Note 1)
Assets  
Current assets:  
Cash and cash equivalents$153,132  $159,317  
Accounts receivable19,091  19,329  
Supplies6,094  6,806  
Prepaid expenses and other current assets3,045  2,235  
Total current assets181,362  187,687  
Property and equipment, net8,788  8,933  
Right-of-use assets - operating lease8,576  8,808  
Finite-lived intangible assets, net63,744  65,019  
Goodwill2,725  2,725  
Restricted cash603  603  
Other assets1,302  1,437  
Total assets$267,100  $275,212  
Liabilities and Stockholders’ Equity  
Current liabilities:  
Accounts payable$7,665  $2,328  
Accrued liabilities10,079  13,734  
Current portion of operating lease liability1,450  1,407  
Total current liabilities19,194  17,469  
Long-term debt748  694  
Acquisition-related contingent consideration5,604  6,088  
Operating lease liability, net of current portion11,132  11,506  
Total liabilities36,678  35,757  
Commitments and contingencies
Stockholders’ equity:  
Preferred stock, $0.001 par value; 5,000,000 shares authorized, no shares issued and outstanding as of March 31, 2020 and December 31, 2019
    
Common stock, $0.001 par value; 125,000,000 shares authorized, 49,999,923 and 49,625,341 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively
50  50  
Additional paid-in capital488,773  486,090  
Accumulated deficit(258,401) (246,685) 
Total stockholders’ equity230,422  239,455  
Total liabilities and stockholders’ equity$267,100  $275,212  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
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VERACYTE, INC.
 
Condensed Consolidated Statements of Operations and Comprehensive Loss
 
(Unaudited)
 
(In thousands, except share and per share amounts)
 
 Three Months Ended March 31,
 20202019
Revenue:
Testing revenue$26,991  $25,389  
Product revenue3,409    
Biopharmaceutical revenue722  4,140  
Total Revenue31,122  29,529  
Operating expenses:  
Cost of testing revenue10,568  8,513  
Cost of product revenue1,559    
Cost of biopharmaceutical revenue116    
Research and development4,407  3,435  
Selling and marketing17,584  12,477  
General and administrative7,813  6,904  
Intangible asset amortization1,275  267  
Total operating expenses43,322  31,596  
Loss from operations(12,200) (2,067) 
Interest expense(55) (303) 
Other income, net539  453  
Net loss and comprehensive loss$(11,716) $(1,917) 
Net loss per common share, basic and diluted$(0.24) $(0.05) 
Shares used to compute net loss per common share, basic and diluted49,792,631  41,168,593  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

2

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VERACYTE, INC.

Condensed Consolidated Statements of Stockholders' Equity

(Unaudited)

(In thousands)

 Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders'
Equity
 Common Stock
 SharesAmount
Balance at December 31, 201949,625  $50  $486,090  $(246,685) $239,455  
Issuance of common stock upon exercise of stock options and vesting of restricted stock units
314  —  981  —  981  
Issuance of common stock under employee stock purchase plan (ESPP)
61  —  1,101  —  1,101  
Tax portion of vested restricted stock units
—  —  (2,304) (2,304) 
Stock-based compensation expense (employee)
—  —  2,551  —  2,551  
Stock-based compensation expense (ESPP)
—  —  354  —  354  
Net loss and comprehensive loss
—  —  —  (11,716) (11,716) 
Balance at March 31, 2020
50,000  $50  $488,773  $(258,401) $230,422  

 Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders'
Equity
 Common Stock
 SharesAmount
Balance at December 31, 201840,863  $41  $313,800  $(234,086) $79,755  
Issuance of common stock upon exercise of stock options and vesting of restricted stock units
566  1  4,239  —  4,240  
Issuance of common stock under ESPP
80  —  491  —  491  
Tax portion of vested restricted stock units
—  —  (556) —  (556) 
Stock-based compensation expense (employee)
—  —  1,598  —  1,598  
Stock-based compensation expense (non-employee)
—  —  20  —  20  
Stock-based compensation expense (ESPP)
—  —  141  —  141  
Net loss and comprehensive loss
—  —  —  (1,917) (1,917) 
Balance at March 31, 2019
41,509  $42  $319,733  $(236,003) $83,772  
 
  The accompanying notes are an integral part of these condensed consolidated financial statements.

3

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VERACYTE, INC.  

Condensed Consolidated Statements of Cash Flows 

(Unaudited) 

(In thousands)
 Three Months Ended March 31,
 20202019
Operating activities  
Net loss$(11,716) $(1,917) 
Adjustments to reconcile net loss to net cash used in operating activities:  
Depreciation and amortization1,972  945  
Gain on disposal of property and equipment  (16) 
Stock-based compensation2,905  1,759  
Amortization of debt issuance costs  8  
Interest on end-of-term debt obligation54  64  
Write-down of excess supplies1,088    
Noncash lease expense232  212  
Revaluation of acquisition-related contingent consideration(484)   
Changes in operating assets and liabilities:
Accounts receivable238  (3,447) 
Supplies(376) (366) 
Prepaid expenses and other current assets(818) (11) 
Operating lease liability(331) (292) 
Other assets 135  37  
Accounts payable5,450  1,726  
Accrued liabilities(3,650) 287  
Net cash used in operating activities(5,301) (1,011) 
Investing activities  
Purchases of property and equipment(665) (765) 
Proceeds from disposal of property and equipment  16  
Net cash used in investing activities(665) (749) 
Financing activities  
Payment of long-term debt  (12,500) 
Payment of finance lease liability  (75) 
Payment of taxes on vested restricted stock units(2,304) (556) 
Proceeds from the exercise of common stock options and employee stock purchases2,085  4,737  
Net cash used in financing activities(219) (8,394) 
Net decrease in cash, cash equivalents and restricted cash(6,185) (10,154) 
Cash, cash equivalents and restricted cash at beginning of period159,920  78,598  
Cash, cash equivalents and restricted cash at end of period$153,735  $68,444  
Supplementary cash flow information:  
Purchases of property and equipment included in accounts payable and accrued liability$113  $95  
Interest paid on debt$1  $228  



4

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Cash, Cash Equivalents and Restricted Cash:
 March 31, 2020December 31, 2019
Cash and cash equivalents$153,132  $159,317  
Restricted cash603  603  
Total cash, cash equivalents and restricted cash$153,735  $159,920  


The accompanying notes are an integral part of these condensed consolidated financial statements.
5

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)

1. Organization and Description of Business
Veracyte, Inc., or Veracyte, or the Company, is a global genomic diagnostics company that improves patient care by providing answers to clinical questions to inform diagnosis and treatment decisions throughout the patient journey in cancer and other diseases. The Company’s growing menu of genomic tests leverage advances in genomic science and technology to change care for patients, enabling them to avoid risky, costly procedures and quicken time to appropriate treatment. With Veracyte’s exclusive global access to a best-in-class diagnostics instrument platform, the Company is positioned to deliver its tests to patients worldwide through laboratories and hospitals that can perform the tests locally.

Veracyte was incorporated in the state of Delaware on August 15, 2006 as Calderome, Inc. Calderome operated as an incubator until early 2008. On March 4, 2008, the Company changed its name to Veracyte, Inc. The Company’s operations are based in South San Francisco, California and Austin, Texas, and it operates in one segment.
 
The Company performs its genomic tests for thyroid cancer, lung cancer and idiopathic pulmonary fibrosis, or IPF, in its CLIA-certified laboratory in South San Francisco, California. In December 2019, the Company announced the exclusive global diagnostics license to the NanoString nCounter FLEX Analysis System, and the acquisition of the Prosigna breast cancer prognostic gene signature assay, which is commercially available, and the LymphMark lymphoma subtyping assay, which is in development. Both tests are designed for use on the nCounter system.

The Company offers genomic tests in four disease areas: thyroid cancer; lung cancer; IPF and breast cancer.

Thyroid Cancer - Afirma Genomic Sequencing Classifier and Xpression Atlas. The Company's Afirma offerings comprise the Afirma GSC and Xpression Atlas, which help guide next steps for patients with potentially cancerous thyroid nodules. The offerings are intended to provide physicians with clinically actionable results from a single fine needle aspiration, or FNA biopsy. The Afirma GSC was developed with RNA whole-transcriptome sequencing and machine learning, and is used to identify patients with benign thyroid nodules among those with indeterminate cytopathology results in order to rule out unnecessary thyroid surgery.

The Afirma Xpression Atlas complements the Afirma GSC by providing genomic alteration content from the same FNA samples used in Afirma GSC testing to help physicians decide with greater confidence on the surgical or therapeutic pathway for their patients. The Company commercially launched the Afirma Xpression Atlas in 2018 and in April 2020 introduced an expanded version of the test, which includes significantly more genomic content.

Lung Cancer - Percepta Genomic Sequencing Classifier. The Percepta classifier improves lung cancer diagnosis when diagnostic bronchoscopy results are inconclusive. This second-generation test was developed using the Company's RNA whole-transcriptome sequencing and machine learning platform and was commercially introduced in June 2019. The Percepta classifier identifies patients with lung nodules who are at low risk of cancer and may avoid further, invasive procedures as well as patients at high risk of cancer so they may obtain faster diagnosis and treatment. The test is built upon foundational "field of injury" science - through which genomic changes associated with lung cancer in current and former smokers can be identified with a simple brushing of a person's airway - without the need to sample the often hard-to-reach nodule directly.

IPF - Envisia Genomic Classifier. The Envisia classifier improves diagnosis of IPF by helping physicians better differentiate IPF from other interstitial lung diseases, or ILDs, without the need for surgery. The test identifies the genomic pattern of usual interstitial pneumonia, or UIP, a hallmark of IPF, with high accuracy on patient samples that are obtained through transbronchial biopsy, a nonsurgical procedure that is commonly used in lung evaluation.

Breast Cancer - Prosigna Breast Cancer Prognostic Gene Signature Assay. The Prosigna test, acquired in December 2019 through the Company's strategic transaction with NanoString, uses advanced genomic technology to inform next steps for patients with early-stage breast cancer, based on the genomic make-up of their disease. The test uses a set of 50 genes known as the PAM50 gene signature and can provide a breast cancer patient and physician with prognostic score that indicates the probability of cancer recurrence over ten years. Physicians use Prosigna to help guide therapeutic decisions so that patients receive a therapeutic intervention, such as
6

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
chemotherapy, only if clinically warranted. Patient test results outside of the United States include intrinsic breast cancer subtypes to complement the risk-of-recurrence score.

The Company’s approach also provides multiple opportunities for partnerships with biopharmaceutical companies. In developing its products, the Company has built or gained access to unique biorepositories, proprietary technology and bioinformatics that it believes are important to the development of new targeted therapies, determining clinical trial eligibility and guiding treatment selection.

The Company's testing services are performed in its clinical reference laboratories located in South San Francisco, California and Austin, Texas. The Prosigna test kits and associated products are sold to laboratories and hospitals in global markets.
Basis of Presentation
The Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet as of March 31, 2020, the condensed consolidated statements of operations and comprehensive loss for the three months ended March 31, 2020 and 2019, the condensed consolidated statements of stockholders' equity for the three months ended March 31, 2020 and 2019, and the condensed consolidated statements of cash flows for the three months ended March 31, 2020 and 2019 are unaudited, but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of its financial position, operating results, stockholders' equity and cash flows for the periods presented. The condensed consolidated balance sheet at December 31, 2019 has been derived from audited financial statements. The results for the three months ended March 31, 2020 are not necessarily indicative of the results expected for the full year or any other period.
The accompanying interim period condensed consolidated financial statements and related financial information included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
Reclassifications

Certain prior period balances have been reclassified to conform to current period presentation of the Company’s condensed consolidated financial statements and accompanying notes. Such reclassifications have no effect on previously reported results of operations, retained earnings or consolidated balance sheet totals; however, for the period ended March 31, 2019, the Company reclassified $212,000 of changes in operating assets and liabilities to noncash lease expense in the statement of cash flows.

Use of Estimates
The preparation of unaudited interim financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Items subject to such estimates include: revenue recognition; write-down of supplies; the useful lives of property and equipment; the recoverability of long-lived assets; the incremental borrowing rate for leases; the estimation of the fair value of intangible assets and contingent consideration; stock options; income tax uncertainties, including a valuation allowance for deferred tax assets; and contingencies. The Company bases these estimates on historical and anticipated results, trends, and various other assumptions that the Company believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates and assumptions.
Issuance of Common Stock in a Public Offering

On May 7, 2019, the Company issued and sold 6,325,000 shares of common stock in a registered public offering, including 825,000 shares issued and sold upon the underwriters’ exercise in full of their option to purchase additional shares, at a price to the public of $23.25 per share. The Company's net proceeds from the offering were approximately $137.8 million, after deducting underwriting discounts and commissions and offering expenses of $9.2 million.
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)

Cash and Cash Equivalents

The Company considers demand deposits in a bank, money market funds and highly liquid investments with an original maturity of 90 days or less to be cash equivalents. Cash equivalents include overnight reverse repurchase agreements which are tri-party repurchase agreements and have maturities of three months or less at the time of investment and are collateralized by U.S. treasury and agency securities of at least 102% of the principal amount. In a tri-party repurchase agreement, a third-party custodian bank functions as an independent intermediary to facilitate transfer of cash and holding the collateral on behalf of the underlying investor for the term of the agreement thereby minimizing risk and exposure to both parties. These overnight reverse repurchase agreements are included within cash equivalents due to their high liquidity and relatively low risk. There were no overnight reverse repurchase agreements at March 31, 2020.

Concentrations of Credit Risk and Other Risks and Uncertainties
The worldwide spread of coronavirus, or COVID-19, has created significant uncertainty in the global economy. There have been no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of COVID-19 and the extent to which COVID-19 impacts the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. If the financial markets or the overall economy are impacted for an extended period, the Company’s liquidity, revenues, supplies, goodwill and intangibles may be adversely affected

The majority of the Company’s cash and cash equivalents are deposited with one major financial institution in the United States. Deposits in this institution may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on its deposits of cash and cash equivalents.
Several of the components of the Company’s sample collection kit and test reagents, and its nCounter FLEX Analysis System and related test kits are obtained from single-source suppliers. If these single-source suppliers fail to satisfy the Company’s requirements on a timely basis, it could suffer delays in being able to deliver its diagnostic solutions, a possible loss of revenue, or incur higher costs, any of which could adversely affect its operating results.
The Company is also subject to credit risk from its accounts receivable related to its sales. Credit risk for accounts receivable from testing revenue is incorporated in testing revenue accrual rates as the Company assesses historical collection rates and current developments to determine accrual rates and amounts the Company will ultimately collect. The Company generally does not perform evaluations of customers’ financial condition for testing revenue and generally does not require collateral. The Company assesses credit risk and the amount of accounts receivable the Company will ultimately collect for product, biopharmaceutical and collaboration revenue based on collection history, current developments and credit worthiness of the customer. The estimate of credit losses is not material at March 31, 2020.
Through March 31, 2020, most of the Company’s revenue has been derived from the sale of Afirma. To date, Afirma has been delivered primarily to physicians in the United States. The Company’s third-party payers and other customers in excess of 10% of total revenue and their related revenue as a percentage of total revenue were as follows:
 Three Months Ended March 31,
 20202019
Medicare25 %21 %
Johnson and Johnson Services, Inc. 13 %
UnitedHealthcare11 %11 %
 36 %45 %
*Less than 10%
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
The Company’s third-party payers and other customers in excess of 10% of accounts receivable and their related accounts receivable balance as a percentage of total accounts receivable were as follows at the following dates:
 March 31,
2020
December 31, 2019
Johnson and Johnson Services, Inc. 10 %
Medicare14 %15 %
*Less than 10%
Restricted Cash
The Company had deposits of $603,000 included in long-term assets as of March 31, 2020 and December 31, 2019, restricted from withdrawal and held by a bank in the form of collateral for an irrevocable standby letter of credit held as security for the lease of the Company’s South San Francisco facility.
Revenue Recognition
Testing Revenue

The Company recognizes testing revenue in accordance with the provisions of ASC 606, Revenue from Contracts with Customers, or ASC 606. Most of the Company’s revenue is generated from the provision of testing services. These services are completed upon the delivery of test results to the prescribing physician, at which time the Company bills for the services. The Company recognizes revenue related to billings based on estimates of the amount that will ultimately be realized. In determining the amount to accrue for a delivered test, the Company considers factors such as payment history, payer coverage, whether there is a reimbursement contract between the payer and the Company, payment as a percentage of agreed upon rate (if applicable), amount paid per test and any current developments or changes that could impact reimbursement. These estimates require significant judgment by management.
For the three months ended March 31, 2019, the Company changed its testing revenue estimates due to actual and anticipated cash collections for tests delivered in 2018 or prior years and recognized additional revenue of $0.6 million, which resulted in a decrease in the Company's loss from operations of $0.6 million and a decrease in loss per share of $0.02 for the three months ended March 31, 2019. The change in testing revenue estimates for the three months ended March 31, 2020 was not material.

Product Revenue

The Company began recognizing product revenue in December 2019, when the Company executed an agreement with NanoString for the exclusive global license to the nCounter platform and acquisition of products for diagnostic use. More details on this agreement are in Note 4 - Business Combination.

Product revenue from instruments, consumables and in vitro diagnostic kits is recognized generally upon shipment or when the instrument is ready for use by the end customer, which is when title of the product has been transferred to the customer. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. Performance obligations are considered satisfied once the Company has transferred control of a product to the customer, meaning the customer has the ability to use and obtain the benefit of the product. The Company recognizes product revenue for satisfied performance obligations only when there are no uncertainties regarding payment terms or transfer of control. Shipping and handling costs incurred for product shipments are charged to the Company's customers and included in product revenue. Revenues are presented net of the taxes that are collected from customers and remitted to governmental authorities.

Biopharmaceutical and Collaboration Revenue

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
From time to time, the Company enters into arrangements for research and development and/or laboratory services. Such arrangements may require the Company to deliver various rights, services and/or samples, including intellectual property rights/licenses, R&D services, and/or laboratory services. The underlying terms of these arrangements generally provide for consideration to the Company in the form of nonrefundable upfront license fees, development and commercial performance milestone payments, royalty payments, and/or profit sharing.

In arrangements involving more than one performance obligation, each required performance obligation is evaluated to determine whether it qualifies as a distinct performance obligation based on whether (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available and (ii) the good or service is separately identifiable from other promises in the contract. The consideration under the arrangement is then allocated to each separate distinct performance obligation based on its respective relative stand-alone selling price. The estimated selling price of each deliverable reflects the Company's best estimate of what the selling price would be if the deliverable was regularly sold by the Company on a stand-alone basis or using an adjusted market assessment approach if selling price on a stand-alone basis is not available.

The consideration allocated to each distinct performance obligation is recognized as revenue when control of the related goods is transferred or services are performed. Consideration associated with at-risk substantive performance milestones is recognized as revenue when it is probable that a significant reversal of the cumulative revenue recognized will not occur. Should there be royalties, the Company utilizes the sales and usage-based royalty exception in arrangements that resulted from the license of intellectual property, recognizing revenues generated from royalties or profit sharing as the underlying sales occur.

Collaborative Arrangements

The Company enters into collaborative arrangements with partners that fall under the scope of ASC Topic 808, Collaborative Arrangements, or ASC 808. While these arrangements are in the scope of ASC 808, the Company may analogize to ASC 606 for some aspects of these arrangements. The Company analogizes to ASC 606 for certain activities within the collaborative arrangement for the delivery of a good or service (i.e., a unit of account) that is part of its ongoing major or central operations.

The terms of the Company’s collaborative arrangements typically include one or more of the following: (i) up-front fees; (ii) milestone payments related to the achievement of development, regulatory, or commercial goals; and (iii) royalties on net sales of licensed products. Each of these payments may result in collaboration revenues or an offset against research and development expense.

Net sales of data or other services to our customers are classified under biopharmaceutical revenue, and all other non-customer revenue, such as milestones, are classified under collaboration revenue in our consolidated statements of operations and comprehensive loss. There was no collaboration revenue in the three months ended March 31, 2020 and 2019.

As part of the accounting for these arrangements, the Company must develop estimates and assumptions that require judgment to determine the underlying stand-alone selling price for each performance obligation which determines how the transaction price is allocated among the performance obligations. Generally, the estimation of the stand-alone selling price may include such estimates as independent evidence of market price, forecasted revenues or costs, development timelines, discount rates, and probabilities of technical and regulatory success. The Company evaluates each performance obligation to determine if they can be satisfied at a point in time or over time, and it measures the services delivered to the collaborative partner which are periodically reviewed based on the progress of the related program. The effect of any change made to an estimated input component and, therefore revenue or expense recognized, would be recorded as a change in estimate. In addition, variable consideration (e.g., milestone payments) must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

Up-front Fees: If a license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from the transaction price allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time.

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
Milestone Payments: At the inception of each arrangement that includes milestone payments (variable consideration), the Company evaluates whether the milestones are considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within the Company’s or the collaborative partner’s control, such as non-operational developmental and regulatory approvals, are generally not considered probable of being achieved until those approvals are received. At the end of each reporting period, the Company re-evaluates the probability of achievement of milestones that are within its or the collaborative partner’s control, such as operational developmental milestones and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect collaboration revenues and earnings in the period of adjustment. Revisions to the Company’s estimate of the transaction price may also result in negative collaboration revenues and earnings in the period of adjustment.

Services Agreement with Loxo Oncology

On April 9, 2018, the Company entered into an agreement with Loxo Oncology, Inc., or Loxo, whereby the Company agreed to provide certain tissue samples and other services in exchange for agreed-upon fees. The agreement has a term of one year with an automatic renewal of one year and Loxo may terminate the agreement at any time with at least 90 days' notice. As of March 31, 2020, the agreement has not been terminated. The Company evaluated the accounting for this agreement under ASC 606 and concluded the performance obligations thereunder are the delivery of tissue samples and performance of services, both of which are distinct. For the three months ended March 31, 2019, the Company recognized revenue of $90,000 for the delivery of tissue samples. There were no deliveries of tissue samples for the three months ended March 31, 2020. The Company recognized revenue of $250,000 for the performance of services for each of the three months ended March 31, 2020 and 2019, respectively. The cost of revenue associated with revenue recognized under the agreement with Loxo is not significant. There was no deferred revenue related to this agreement at either March 31, 2020 or December 31, 2019.
Diagnostic Development Agreement with Johnson & Johnson

On December 28, 2018, the Company entered into a diagnostics development agreement with Johnson and Johnson Services, Inc., or JJSI, (i) to cooperate on a program to enable the Company to use JJSI samples and clinical data to develop a next generation bronchial genomic classifier diagnostic for lung cancer diagnosis, or Percepta v.2, and a nasal genomic classifier diagnostic for lung cancer and (ii) for JJSI to use Veracyte data generated in two Veracyte development programs for therapeutic purposes and for purposes of developing a companion diagnostic product used in conjunction with a JJSI therapeutic. The Company granted a license to JJSI with the right to use data and under the Company's intellectual property rights for JJSI's therapeutic purposes, including the development and commercialization of a companion diagnostic for its products, from the Percepta v.2 and Nasal programs. The license granted to JJSI is not distinct from other performance obligations as JJSI receives benefit only when other performance obligations are met.
Under the terms of the agreement, the Company will provide data from its RNA whole-transcriptome sequencing platform to JJSI in exchange for $7.0 million in payments from JJSI. The Company is also entitled to additional payments from JJSI of up to $13.0 million, conditioned upon the achievement of certain milestones relating to the development and reimbursement of the Percepta v.2 and Nasal tests. For a period of ten years commencing with the first commercial sale of the Percepta v.2 and Nasal tests, respectively, the Company will make payments to JJSI of one percent of net cash collections for Percepta v.2 and in the low-single digits of net cash collections for the Nasal test, depending on the number and timing of JJSI samples and associated clinical data the Company receives from JJSI.

The JJSI agreement is considered to be within the scope of ASC 808, as the parties are active participants and exposed to the risks and rewards of the collaborative activity. The Company evaluated the terms of the JJSI agreement and has analogized to ASC 606 for the delivery of RNA whole-transcriptome sequencing data to JJSI under the collaborative arrangement, which the Company believes is a distinct service for which JJSI meets the definition of a customer. Using the concepts of ASC 606, the Company has identified the delivery of data as its only performance obligation. The Company further determined that the transaction price under the arrangement was the $7.0 million in payments which was allocated to the obligation to deliver data. The $13.0 million in future potential payments is considered variable consideration because the Company determined that the potential payments are contingent upon
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
regulatory and commercialization milestones that are uncertain to occur and, as such, were not included in the transaction price, and will be recognized accordingly as each potential payment becomes probable.

The Company recognized revenue of $7.0 million and $4.0 million during 2019 for the provision of data and fulfillment of obligations relating to Percepta v.2 and Nasal program development milestones, respectively. There was no revenue for the three months ended March 31, 2020. For the three months ended March 31, 2019, the Company recognized revenue of $3.8 million for the provision of data relating to Percepta v.2, classified under biopharmaceutical revenue in the consolidated statement of operations and comprehensive loss. There was no accounts receivable from JJSI at March 31, 2020 and accounts receivable from JJSI was $2.0 million at December 31, 2019. There was no deferred revenue related to this agreement at March 31, 2020 and December 31, 2019.
Collaboration Agreement with AstraZeneca Group

On December 23, 2019, the Company entered into an agreement with Acerta Pharma B.V., or Acerta, a member of AstraZeneca Group whereby the Company agreed to provide genomic information that will support Acerta’s development of oncology therapeutics. Acerta will pay the Company for certain development activities and pay milestones to the Company for the achievement of development milestones. For the three months ended March 31, 2020, the Company recognized $0.1 million of revenue for certain development costs activities and accounts receivable from Acerta was $0.1 million at March 31, 2020. The agreement will be accounted for in accordance with the policy on collaborative arrangements, as mentioned in this footnote.

Biopharmaceutical Services Agreement

During the quarter ended March 31, 2020, the Company entered into an agreement to provide research and development services of $0.5 million for which the Company recognized $0.3 million of biopharmaceutical revenue for the three months ended March 31, 2020.

Cost of Testing Revenue

The components of our cost of testing services are laboratory expenses, sample collection expenses, compensation expense, license fees and royalties, depreciation and amortization, other expenses such as equipment and laboratory supplies, and allocations of facility and information technology expenses. Costs associated with performing tests are expensed as the test is processed regardless of whether and when revenue is recognized with respect to that test. Cost of testing revenue for the three months ended March 31, 2020 included $1.1 million write-down of supplies for the potential expiration of reagents due to an anticipated decline in volumes resulting from the COVID-19 pandemic.

Cost of Product Revenue

Cost of product revenue consists primarily of costs of purchasing instruments and consumables from third-party contract manufacturers, installation, warranty, service and packaging and delivery costs. In addition, cost of product includes royalty costs for licensed technologies included in the Company’s products and labor expenses. Cost of product revenue for instruments and consumables is recognized in the period the related revenue is recognized. Shipping and handling costs incurred for product shipments are included in cost of product in the consolidated statements of operations.

Cost of Biopharmaceutical Revenue

Cost of biopharmaceutical revenue consists of costs of performing activities under arrangements that require the Company to perform research and development services on behalf of a customer pursuant to a biopharmaceutical service agreement.

Recent Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. This ASU requires entities to estimate an expected lifetime credit loss on financial assets ranging from short-term trade accounts receivable to long-term financings and report credit losses using an expected losses model rather than the incurred losses model that was previously used, and establishes additional disclosures related to credit
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
risks. This guidance became effective for the Company beginning January 1, 2020. Based on the composition of its trade receivables, investment portfolio and other financial assets, current economic conditions and historical credit loss activity, the adoption of this standard did not have a material impact on the Company's condensed consolidated financial statements and related disclosures.

In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangements (Topic 808). Under this ASU, transactions in collaborative arrangements are to be accounted for under ASC 606 if the counterparty is a customer for a good or service (or bundle of goods and services) that is a distinct unit of account. Also, entities are precluded from presenting consideration from transactions with a counterparty that is not a customer together with revenue recognized from ASC 606. This ASU is effective for all interim and annual reporting periods beginning on or after December 15, 2019, with early adoption permitted. The Company adopted this ASU in 2019 with no cumulative-effect adjustments or retrospective impact.

In August 2018 the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This standard clarifies the accounting for implementation costs in cloud computing arrangements. This standard became effective for the Company on January 1, 2020, and was adopted on a prospective basis with no material impact on the Company's condensed consolidated financial statements.

2. Net Loss Per Common Share
 
Basic net loss per common share is calculated by dividing net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration of common stock equivalents. Diluted net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted-average number of common share equivalents outstanding for the period determined using the treasury stock method. The following outstanding common stock equivalents have been excluded from diluted net loss per common share because their inclusion would be anti-dilutive:
 Three Months Ended March 31,
 20202019
Shares of common stock subject to outstanding options4,760,128  5,670,819  
Employee stock purchase plan19,857  25,672  
Restricted stock units936,524  538,759  
Total common stock equivalents5,716,509  6,235,250  

3. Accrued Liabilities
 
Accrued liabilities consisted of the following (in thousands of dollars):
 
 March 31,
2020
December 31,
2019
Accrued compensation expenses$7,497  $10,100  
Accrued other2,582  3,634  
Total accrued liabilities$10,079  $13,734  

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
4. Business Combination

On December 3, 2019, the Company executed an agreement with NanoString for the exclusive global diagnostics license to the nCounter FLEX Analysis System, and the acquisition of the Prosigna breast cancer prognostic gene signature assay, and the LymphMark lymphoma subtyping assay. The strategic transaction positions the Company to expand its genomic diagnostics business globally, with the ability to deliver its advanced genomic tests to physicians and their patients via hospital and clinical laboratories throughout the European Union and other parts of the world. The Company has accounted for this agreement under Accounting Standards Codification 805, Business Combinations. Pursuant to the terms of the agreement, Veracyte paid NanoString $40.0 million in cash and $10.0 million in Veracyte common stock, and may pay up to an additional $10.0 million in cash, contingent upon the commercial launch of Veracyte diagnostic tests for use on the platform. This contingency was valued at $6.1 million as of the acquisition date and as of December 31, 2019, recorded as a liability, and will be remeasured to fair value at each reporting date until the contingent consideration is settled. As of March 31, 2020, this contingency was remeasured to $5.6 million with the corresponding change included in general and administrative expense in the Company's condensed consolidated statements of operations and comprehensive loss.

Assets acquired are recorded based on valuations derived from estimated fair value assessments and assumptions used by the Company. While the Company believes that its estimates and assumptions underlying the valuations are reasonable, different estimates and assumptions could result in different valuations assigned to the individual assets acquired and the resulting amount of goodwill. The following table summarizes the fair values of assets acquired and liabilities assumed at the date of acquisition (in thousands):

Prosigna product technology$4,120  
Prosigna customer relationships2,430  
nCounter FLEX Dx license46,880  
LymphMark product technology990  
Total identifiable intangible assets acquired54,420  
Goodwill1,668  
Net assets acquired$56,088  


Identifiable acquisition-related intangibles included in the above table are finite-lived and are being amortized on a straight-line basis over their estimated lives, which approximates the pattern in which the economic benefits of the intangible assets are expected to be realized, as follows:

Estimated Useful life (In Years)
Prosigna product technology15
Prosigna customer relationships5
nCounter FLEX Dx license15
LymphMark product technology7


Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. This acquisition includes $1.7 million of goodwill which the Company believes consists principally of the organized workforce that will help the Company execute its strategic plans in relation to the assets acquired. In accordance with ASC 350, goodwill will not be amortized but will be tested for impairment at least annually. As of March 31, 2020, goodwill is not deductible for tax purposes, however, if contingent consideration is paid at a future date, the portions of contingent consideration paid and allocated to the intangible assets for tax purposes will be tax deductible. The accounting for this acquisition is preliminary and will be finalized upon completion of the analysis of certain contracts acquired and executed as part of this acquisition along with the impact on goodwill, should there be any.

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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
5. Fair Value Measurements
 
The Company records its financial assets and liabilities at fair value. The carrying amounts of certain financial instruments of the Company, including cash and cash equivalents, prepaid expenses and other current assets, accounts payable and accrued liabilities, approximate fair value due to their relatively short maturities. The accounting guidance for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:
 
Level I: Inputs which include quoted prices in active markets for identical assets and liabilities;

Level II: Inputs other than Level I that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

Level III: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
The fair value of the Company’s financial assets includes money market funds, overnight reverse repurchase agreements and a deposit for the lease of the Company's South San Francisco facility. Money market funds, included in cash and cash equivalents in the accompanying condensed consolidated balance sheets, were $150.7 million and $57.6 million as of March 31, 2020 and December 31, 2019, respectively, and are Level I assets as described above. Overnight reverse repurchase agreements, included in cash and cash equivalents in the accompanying condensed consolidated balance sheets, were zero and $100.0 million as of March 31, 2020 and December 31, 2019, respectively, and are Level II assets as described above. There were no unrealized gains or losses from overnight reverse repurchase agreements at March 31, 2020 and December 31, 2019. The deposit for the lease, included in restricted cash in the accompanying condensed consolidated balance sheets, was $603,000 as of March 31, 2020 and December 31, 2019, and is a Level I asset as described above.
 
The contingent consideration in Note 4, Business Combination, associated with the agreement with NanoString on December 3, 2019, is a Level III financial liability. The estimation of the fair value of the contingent consideration is based on the present value of the expected payments calculated by assessing the likelihood of when the related milestones would be achieved, discounted using the Company's estimated borrowing rate. These estimates form the basis for making judgments about the carrying value of the contingent consideration that are not readily apparent from other sources. Changes to the forecasts for the achievement of the milestones and the estimates of the borrowing rate can significantly affect the estimated fair value of the contingent consideration.

6. Commitments and Contingencies
 
Operating Leases
 
The Company leases its headquarters and laboratory facilities in South San Francisco, California under a non-cancelable lease agreement for approximately 59,000 square feet. The lease began in June 2015 and ends in March 2026 and contains extension of lease term and expansion options. The Company had deposits of $603,000 included in long-term assets as of March 31, 2020 and December 31, 2019, restricted from withdrawal and held by a bank in the form of collateral for an irrevocable standby letter of credit held as security for the lease of the South San Francisco facility.
 
The Company also leases laboratory and office space in Austin, Texas under a lease that expires in January 2029 and includes options for expansion and early termination in 2025. The Company provided a cash security deposit for this lease of $139,000, included in other assets in the Company’s condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019.

Future minimum lease payments under non-cancelable operating leases as of March 31, 2020 are as follows (in thousands of dollars):
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
 
Year Ending December 31,
Remainder of 2020$1,760  
20212,401  
20222,472  
20232,543  
20242,614  
Thereafter4,227  
Total future minimum lease payments16,017  
Less: amount representing interest3,435  
Present value of future lease payments12,582  
Less: short-term lease liabilities1,450  
Long-term lease liabilities$11,132  
 
The Company recognizes operating lease expense on a straight-line basis over the non-cancelable lease period. Operating lease expense was $474,000 and $476,000 for the three months ended March 31, 2020 and 2019, respectively.

Contingencies
 
From time to time, the Company may be involved in legal proceedings arising in the ordinary course of business. The Company assesses contingencies to determine the degree of probability and range of possible loss for potential accrual in its condensed consolidated financial statements. An estimated loss contingency is accrued in the financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company believes there is no legal proceeding pending that could have, either individually or in the aggregate, a material adverse effect on the Company’s condensed consolidated financial statements.
 
7. Debt
 
Loan and Security Agreement

On November 3, 2017, the Company entered into a loan and security agreement, or Loan and Security Agreement, with Silicon Valley Bank. The Loan and Security Agreement allows the Company to borrow up to $35.0 million, with a $25.0 million advance term loan, or Term Loan Advance, and a revolving line of credit of up to $10.0 million, or Revolving Line of Credit. The Term Loan Advance was advanced upon the closing of the Loan and Security Agreement and was used to pay the outstanding balance of the Company’s existing long-term debt, which was canceled at that date. The Company had not drawn on the Revolving Line of Credit as of March 31, 2020. Borrowings under the Loan and Security Agreement mature on October 1, 2022. Amounts may be borrowed and repaid under the Revolving Line of Credit up until the earliest of full repayment or maturity of the Loan and Security Agreement, termination of the Loan and Security Agreement, or October 1, 2022.

The Term Loan Advance bears interest at a variable rate equal to (i) the thirty-day U.S. London Interbank Offer Rate, or LIBOR, plus (ii) 4.20%, with a minimum rate of 5.43% per annum. Principal amounts outstanding under the Revolving Line of Credit bear interest at a variable rate equal to (i) LIBOR plus (ii) 3.50%, with a minimum rate of 4.70% per annum. The average Term Loan Advance interest rate for the three months ended March 31, 2020 was 5.8%.

The Company may prepay the outstanding principal amount under the Term Loan Advance plus accrued and unpaid interest and, if the Term Loan Advance is repaid in full, a prepayment premium. The prepayment premium will be (i) $750,000 if prepayment is made prior to November 3, 2018, (ii) $500,000 if the prepayment is made after November 3, 2018 but on or before November 3, 2019, or (iii) $250,000 if the prepayment is made after November 3, 2019. In January 2019 and May 2019, the Company prepaid $12.5 million and $12.4 million, respectively, of the principal amount of the Term Loan Advance. These prepayments did not trigger any prepayment premium because they were partial, not full, repayments of the principal amount.

In addition, a final payment on the Term Loan Advance in the amount of $1.2 million is due upon the earlier of the maturity date of the Term Loan Advance or its payment in full. The Loan and Security Agreement contains customary
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VERACYTE, INC.
Notes to Financial Statements
(unaudited)
representations, warranties, and events of default such as a material adverse change in the Company's business, operations or financial condition, as well as affirmative and negative covenants. The negative covenants include, among other provisions, covenants that limit or restrict the Company's ability to incur liens, make investments, incur indebtedness, merge with or acquire other entities, dispose of assets, make dividends or other distributions to holders of its equity interests, engage in any new line of business, or enter into certain transactions with affiliates, in each case subject to certain exceptions. The Company’s obligations under the Loan and Security Agreement are secured by substantially all of its assets (excluding intellectual property), subject to certain customary exceptions. The Loan and Security Agreement also requires the Company to achieve certain revenue levels tested quarterly on a trailing twelve-month basis. However, failure to maintain the revenue levels will not be considered a default if the sum of the Company’s unrestricted cash and cash equivalents maintained with Silicon Valley Bank and amount available under the Revolving Line of Credit is at least $40.0 million. As of March 31, 2020, the Company was in compliance with the loan covenants.

The net debt obligation for borrowings made under the Loan and Security Agreement was as follows (in thousands of dollars):
 
 March 31, 2020December 31, 2019
Debt principal$100  $100  
End-of-term debt obligation648  594  
Net debt obligation$748  $694  

Future principal and end-of-term debt obligation payments under the Loan and Security Agreement are $1.3 million and due in 2022.  

The end-of-term debt obligation accretes over the term of the Loan and Security Agreement until maturity and is included in interest expense in the Company's condensed consolidated statements of operations and comprehensive loss.
 
8. Stockholders’ Equity
 
Common Stock
 
The Company had reserved shares of common stock for issuance as follows:
 
 March 31,
2020
December 31, 2019
Stock options and restricted stock units issued and outstanding5,988,461  5,562,484  
Stock options and restricted stock units available for grant under stock option plans3,200,200  1,954,804  
Common stock available for the Employee Stock Purchase Plan112,226  173,168  
Total9,300,887  7,690,456  

9. Thyroid Cytopathology Partners
 
The Company has an agreement with a specialized pathology practice, Thyroid Cytopathology Partners, ("TCP"), to provide testing services to the Company, or TCP Agreement.  The TCP Agreement is effective through October 31, 2022, and thereafter automatically renews every year unless either party provides notice of intent not to renew at least 12 months prior to the end of the then-current term. Under the TCP Agreement, the Company pays TCP based on a fixed price per test schedule which is reviewed periodically for changes in market pricing, and the TCP Agreement included a clause allowing TCP to sublease a portion of the Company's facility in Austin, Texas.  The Company does not have an ownership interest in or provide any form of financial or other support to TCP.  The Company previously concluded that TCP represented a variable interest entity as a result of the facility arrangement clause, but that the Company was not the primary beneficiary as it did not have the ability to direct the activities that most significantly impacted TCP's economic performance, and therefore did not consolidate TCP.  On February 14, 2019, the TCP Agreement was amended to remove the facility clause.  Accordingly, the Company believes TCP was no longer a variable interest entity as of that date.
 
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Table of Contents
VERACYTE, INC.
Notes to Financial Statements
(unaudited)
TCP's portion of rent and related operating expenses reimbursed to the Company for the shared space at the Austin, Texas facility was $11,000 for the three months ended March 31, 2019, and is included in other income, net in the Company’s condensed consolidated statements of operations and comprehensive loss.

10. Income Taxes
 
The Company did not record a provision or benefit for income taxes during the three months ended March 31, 2020 and 2019. The Company continues to maintain a full valuation allowance against its net deferred tax assets.
 
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The Company does not expect the provisions of the legislation to have a significant impact on the effective tax rate of the Company.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of financial condition and results of operations should be read together with the condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q, and with our audited financial statements and the related notes included in our Annual Report on Form 10-K for the year ended December 31, 2019.
 
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the words "expects," "anticipates," "intends," "estimates," "plans," "believes," "continuing," "ongoing," and similar expressions are intended to identify forward-looking statements. These are statements that relate to future events and include, but are not limited to, the factors that may impact our financial results; our expectations regarding revenue; our expectations with respect to our future research and development, general and administrative and selling and marketing expenses and our anticipated uses of our funds; the impact of the COVID-19 pandemic on our business and the U.S. and global economies; our beliefs with respect to the optimization of our processes for the analysis of ribonucleic acid, or RNA, samples; our integration of the assets acquired from NanoString Technologies, Inc.; our ability to deploy the nCounter FLEX Analysis System successfully and run our tests on this platform worldwide; our beliefs with respect to the optimization of our processes for the analysis of ribonucleic acid, or RNA, samples; our collaboration with Johnson & Johnson Services, Inc.; our belief in the importance of maintaining libraries of clinical evidence; our expectations regarding capital expenditures; our anticipated cash needs and our estimates regarding our capital requirements; the timing and success of our transition to a single platform for all of our classifiers and tests; our ability to maintain Medicare coverage for each of our tests; our need for additional financing; potential future sources of cash; our business strategy and our ability to execute our strategy; our ability to achieve and maintain reimbursement from third-party payers at acceptable levels and our expectations regarding the timing of reimbursement; the estimated size of the global markets for our tests; the estimated number of patients who receive uncertain diagnoses who are candidates for our test; the attributes and potential benefits of our tests and any future tests we may develop to patients, physicians and payers; the factors we believe drive demand for and reimbursement of our tests; our ability to sustain or increase demand for our tests; our intent to expand into other clinical areas; our ability to develop new tests, and the timeframes for development or commercialization; our ability to get our data and clinical studies accepted in peer-reviewed publications; our dependence on and the terms of our agreement with TCP, and on other strategic relationships, and the success of those relationships; our beliefs regarding our laboratory capacity; the potential for future clinical studies to contradict or undermine previously published clinical study results; the applicability of clinical results to actual outcomes; our expectations regarding our international expansion; the occurrence, timing, outcome or success of clinical trials or studies; the ability of our tests to impact treatment decisions; our beliefs regarding our competitive position; our compliance with federal, state and international regulations; the potential impact of regulation of our tests by the Food and Drug Administration, or FDA, or other regulatory bodies; the impact of new or changing policies, regulation or legislation, or of judicial decisions, on our business; the impact of seasonal fluctuations and economic conditions on our business; our belief that we have taken reasonable steps to protect our intellectual property; our belief that our intellectual property will develop and maintain our competitive position; the impact of accounting pronouncements and our critical accounting policies, judgments, estimates, models and assumptions on our financial results; and anticipated trends and challenges in our business and the markets in which we operate. We caution you that the foregoing list does not contain all of the forward-looking statements made in this report.
 
Forward-looking statements are based on our current plans and expectations and involve risks and uncertainties which could cause actual results to differ materially. These risks and uncertainties include, but are not limited to, those risks discussed in Part II, Item 1A of this report. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to update any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

When used in this report, all references to "Veracyte," the "company," "we," "our" and "us" refer to Veracyte, Inc.

Veracyte, Afirma, Percepta, Envisia, Prosigna, LymphMark, and Know by Design, and the Veracyte, Afirma, Percepta, Envisia and Prosigna logos are our trademarks. We also refer to trademarks of other corporations or organizations in this report.

This report contains statistical data and estimates that we obtained from industry publications and reports. These publications typically indicate that they have obtained their information from sources they believe to be reliable, but do not guarantee the accuracy and completeness of their information. Some data contained in this report is also based on our internal estimates.
 
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Overview
 
        We are a global genomic diagnostics company that improves patient care by providing answers to clinical questions to inform diagnosis and treatment decisions throughout the patient journey in cancer and other diseases. The Company’s growing menu of genomic tests leverage advances in genomic science and technology to change care for patients, enabling them to avoid risky, costly procedures and quicken time to appropriate treatment. With Veracyte’s exclusive global access to a best-in-class diagnostics instrument platform, the Company is positioned to deliver its tests to patients worldwide through laboratories and hospitals that can perform the tests locally.

We perform our genomic tests for thyroid cancer, lung cancer and idiopathic pulmonary fibrosis, or IPF, in our CLIA-certified laboratory in South San Francisco, California. In December 2019, we announced an exclusive global diagnostics license to the nCounter® FLEX Analysis System from NanoString Technologies, Inc., or NanoString, as well as the acquisition of the Prosigna® breast cancer prognostic gene signature assay, which is commercially available, and the LymphMark™ lymphoma subtyping assay, which is in development. Both tests are designed for use on the nCounter system. We believe this strategic transaction positions us to expand our business globally with a broad menu of advanced genomic tests that may be offered as distributed kits and performed in local laboratories worldwide. We believe our current and pipeline products address a collective $40 billion global market.

We develop our genomic tests using advanced scientific methods, such as RNA whole-transcriptome sequencing and machine learning, and then optimize the assay and classifier results for the platform on which the test will be performed. Historically, that platform has been RNA sequencing, performed in our CLIA lab. In the future, we expect this to also include the nCounter platform for international distribution of our tests.

Our classifiers are designed to improve diagnostic and prognostic clarity for cancer and other diseases. In its 2015 report, “Improving Diagnostic Errors in Medicine,” the Institute of Medicine concluded that most people will experience at least one diagnostic error in their lifetime, sometimes with devastating consequences. Annually, of the hundreds of thousands of patients who are evaluated for suspected disease in our thyroid and lung indications, diagnosis can be ambiguous in 15-70% of cases. This diagnostic uncertainty can lead to additional, invasive procedures that are often unnecessary, delayed or incorrect treatment, increased healthcare costs and patient anxiety.

We position our tests to fit into the way physicians currently evaluate patients in order to facilitate adoption. We also design our tests to improve patient care and outcomes, while delivering clinical and economic utility to physicians, payers and the healthcare system in general.

We believe our powerful scientific platform provides multiple vectors to create value for patients, providers and payers, as well as stockholders, and to help advance precision medicine:

Unique Biorepositories - When we develop new tests, we build extensive, robust biorepositories of patient-consented samples and well-curated clinical, radiological, outcome and other information from Institutional Review Board-approved clinical trials to inform our discovery efforts. Our biorepositories are designed to encompass the broad spectrum of disease that our tests may encounter when used in clinical practice, as well as the wide range of conditions associated with patients who are suspected of having a particular disease. We extract extensive genomic information from these patient samples using our RNA whole-transcriptome sequencing platform.

Proprietary Technology and Bioinformatics - For biomarker discovery and product development, we utilize machine learning to select the genomic, clinical or other features from our biorepository that best distinguish the condition we are trying to identify. This enables us to develop high-performing genomic classifiers that can answer specific clinical questions. In addition, our bioinformatics pipelines are built to extract genomic variant content from the same assay to inform therapeutic selection.

High-Performing Commercial Genomic Tests – With the exception of Prosigna, which competes with a first-to-market test in a highly competitive environment, our genomic tests generally serve large, untapped markets where they are changing the diagnostic and treatment paradigm for patients. We believe the nCounter platform affords us the opportunity to adapt our test menu for multiple markets globally, providing flexibility for a global distributed testing model and potentially increased efficiency in our United States-based CLIA lab. Regardless of the testing platform used for diagnosis, our RNA sequencing platform enables us to offer testing from our CLIA lab for a broad range of gene alterations, which can inform treatment decisions using the same pre-surgical patient sample that was used in diagnosis.
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We believe our ability to leverage RNA whole-transcriptome sequencing data in large biorepositories of patient-consented samples in oncology and other indications presents an opportunity for biopharmaceutical companies to enhance their research and development capabilities. In April 2018, we announced a collaboration with Loxo Oncology (now a wholly owned subsidiary of Eli Lilly and Company) to advance its development of highly selective medicines for patients with genetically defined cancers, including thyroid cancer. In December 2018, we entered into a long-term strategic collaboration with Johnson & Johnson Innovation and the Lung Cancer Initiative at Johnson & Johnson to advance the development and commercialization of novel diagnostic tests to detect lung cancer at its earliest stages, when the disease is most treatable. The collaboration builds upon foundational "field of injury" science whereby genomic changes associated with lung cancer can be identified with a simple brushing of a person's airway to develop new interventions that can save lives. Additionally, in January 2020, we announced an agreement with Acerta Pharma, the hematology research and development arm of AstraZeneca, to provide genomic information that will support its development of oncology therapeutics in lymphoma.

Our collaboration with the Lung Cancer Initiative at Johnson & Johnson has helped accelerate two of our key lung cancer programs: (i) commercialization of the Percepta GSC on our RNA whole-transcriptome sequencing platform, and (ii) development of the first non-invasive nasal swab test for early lung cancer detection. We began making the Percepta GSC available to customers in June 2019. In October 2019, we announced preliminary data for our nasal swab classifier, which demonstrated the test’s potential to identify patients at low risk of lung cancer so they can potentially avoid unnecessary procedures and those at high risk so they can receive prompt diagnosis and treatment.

The published evidence supporting our tests demonstrates the robustness of our science and clinical studies, which we believe is key to driving adoption and reimbursement. Patients and physicians can access our full list of publications on our website. Over 45 clinical studies covering our products have been published, including three landmark clinical validation papers published in The New England Journal of Medicine for the Afirma and Percepta classifiers, respectively, and in The Lancet Respiratory Medicine for the Envisia classifier. We continue to build upon our extensive library of clinical evidence.

We believe our focus on developing clinically useful tests that change patient care is enabling the company to set new standards in genomic test reimbursement. Our genomic classifiers in thyroid cancer, lung cancer and IPF, as well as the Prosigna breast cancer assay are covered by Medicare. Our Afirma classifier, for use in thyroid cancer diagnosis, is now covered by every major health plan in the United States, which collectively insure more than 275 million people. We are contracted as an in-network service provider to health plans representing over 225 million people in the United States. We believe that our in-network status with private payers will help facilitate private insurer reimbursement for our Percepta and Envisia classifiers. The Prosigna test is covered by leading private payers in the United States and is widely reimbursed by government and private payers in the countries where it is available.

We also expect to continue expanding our offerings in thyroid cancer, lung cancer, interstitial lung diseases such as IPF, breast cancer and lymphoma, as well as other indications that we believe will benefit from our technology and approach. Our product development pipelines address what we believe to be significant market opportunities for addressing clinical questions in early detection, diagnosis, staging/prognosis, therapy selection/surgery and disease monitoring across the aforementioned indications.

Impact of COVID-19

In December 2019, a strain of coronavirus was reported in Wuhan, China, and began to spread globally, including to the United States and Europe, in the following months. The World Health Organization has declared COVID-19 to be a pandemic and a public health emergency of international concern. The full impact of the COVID-19 outbreak is inherently uncertain at the time of this report. The COVID-19 outbreak has resulted in travel restrictions and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. As COVID-19 has spread, it has significantly impacted the health and economic environment around the world and many governments have closed most public establishments, including restaurants, workplaces and schools. Our customers, third-party contract manufacturers, suppliers and collaboration partners may be affected by the closure of hospitals, doctors offices, manufacturing sites, or country borders, among other measures being put in place around the world. Consequent increases in layoffs and furloughs in the medical industry and otherwise during the shutdown are having, and will continue to have, negative impact on the demand for medical care and diagnostic tests, which affects the frequency with which tests are prescribed, and the ability of doctors and hospitals to administer such tests. Further the inability to travel and conduct face-to-face meetings can also make it more difficult to expand utilization of our products into new geographies and to drive awareness of our products. Any of these circumstances will potentially have a negative impact on our financial results and liquidity in fiscal 2020.

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As for our own business, during the second half of March 2020 through the date of this filing, we experienced a significant decline in the volume of samples received resulting in a significant decline in revenue and it is currently unclear how long we will continue to experience decreased sample volumes and levels of revenue. The COVID-19 pandemic has also caused us to modify our business practices, including taking proactive steps to protect our employees and the broader community (including but not limited to curtailing or modifying employee travel, moving to full remote work wherever possible, and cancelling physical participation in meetings, events and conferences), while ensuring our ability to deliver genomic test results to physicians and their patients who need them. Given the significant challenges we face from COVID-19, we have taken actions to reduce expenses and preserve the health of our business, including our board of directors, executive team, including our Chairman and CEO, and certain other employees taking a reduction in pay until we are able to resume normal operations. We have also put approximately 60 employees on a temporary furlough with a current goal of bringing them back from furlough in the future, terminated a small number of employees, and instituted a temporary hiring freeze. We may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.

The extent of the impact of the COVID-19 on our future liquidity and operational performance will depend on certain developments, including the duration and spread of the outbreak, the impact on our customers' operations and the impact to our sales and renewal cycles.

First Quarter 2020 Financial Results

For the first quarter of 2020, as compared with the first quarter of 2019:

Total Testing and Product Revenue was $30.4 million, an increase of 20%; including biopharmaceutical revenue, total revenue was $31.1 million, an increase of 5%;
Gross Margin was 61%, which included a $1.1 million write-down of supplies;
Operating Expenses, Excluding Cost of Revenue, were $31.1 million, an increase of 35%;
Net Loss and Comprehensive Loss was $(11.7) million, versus $(1.9) million;
Basic and Diluted Net Loss Per Common Share was $(0.24), versus $(0.05);
Net Cash Used in Operating Activities was $5.3 million, versus $1.0 million; and
Cash and Cash Equivalents were $153.1 million at March 31, 2020.

First Quarter 2020 and Recent Business Highlights

Core Diagnostics Business:
Grew total genomic test volume (Afirma, Percepta and Envisia) by 15% to 10,559 tests.
Launched “More About You,” a national campaign to help patients navigate the work-up of thyroid nodules and ask for Afirma testing by name.
Announced that data accepted for oral presentation at the ENDO 2020 conference identified novel or rare gene fusions that are included in the newly expanded Afirma Xpression Atlas and may potentially be targeted with drugs that are approved or under development.
Reported new data published in npj Breast Cancer, which suggest potential growth opportunities for the Prosigna test in global markets where the test reports intrinsic breast cancer subtypes. Additionally, data published in Clinical Breast Cancer suggest the Prosigna test’s ability to provide significant prognostic information beyond clinicopathologic factors in patients with invasive lobular breast cancer, a major breast cancer histopathologic subtype.

Strategic Collaborations and Pipeline Advancement:
Secured an exclusive licensing and research agreement with Yale University to advance the first genomic monitoring test for idiopathic pulmonary fibrosis prognosis, complementing our Envisia classifier for improved early diagnosis of the disease. The non-invasive, blood-based test was developed for use on our nCounter diagnostic platform.
Signed an exclusive licensing agreement with Boston University for technology that will help advance development of the first-ever, non-invasive nasal swab test for lung cancer early detection.
Announced a multi-year collaboration with Acerta Pharma, the hematology research and development arm of AstraZeneca plc, to provide genomic information that will support the biopharmaceutical company’s development of oncology therapeutics in lymphoma.

Factors Affecting Our Performance
 
Impact of COVID-19

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The extent of the impact of the COVID-19 outbreak on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, impact on our customers and our sales cycles, employee or industry events, and effect on our vendors, all of which are uncertain and cannot be predicted. The COVID-19 pandemic and its adverse effects have become more prevalent in the locations where we, our customers, suppliers or third-party business partners conduct business and as a result, we have begun to experience more pronounced disruptions in our operations. We may experience constrained supply or curtailed customer demand that could materially adversely impact our business, results of operations and overall financial performance in future periods. Specifically, we may experience impact from changes in how hospital and physicians treat their patients and the frequency of their interaction with their patients, our ability to have in-person meetings with physicians and other customers and drive education and interest in our tests, and difficulties and changes to our sales, logistics, testing, customer support and other processes. As of the filing date of this Form 10-Q, the extent to which COVID-19 may impact our financial condition or results of operations or guidance is uncertain. The effect of the COVID-19 pandemic will not be fully reflected in our results of operations and overall financial performance until future periods. See Risk Factors for further discussion of the possible impact of the COVID-19 pandemic on our business.

Reported Genomic Test Volume
 
Our performance depends on the number of genomic tests that we perform and report as completed in our CLIA laboratories. Factors impacting the number of tests that we report as completed include, but are not limited to:

the impact of COVID-19 on patients seeking to have tests performed;
the number of samples that we receive that meet the medical indication for each test performed;
the quantity and quality of the sample received;
receipt of the necessary documentation, such as physician order and patient consent, required to perform, bill and collect for our tests;
the patient's ability to pay or provide necessary insurance coverage for the tests performed;
the time it takes us to perform our tests and report the results;
the seasonality inherent in our business, such as the impact of work days per period, timing of industry conferences and the timing of when patient deductibles are exceeded, which also impacts the reimbursement we receive from insurers; and
our ability to obtain prior authorization or meet other requirements instituted by payers, benefit managers, or regulators necessary to be paid for our tests.

We generate substantially all our revenue from genomic testing services, including the rendering of a cytopathology diagnosis as part of the Afirma solution. For the Afirma classifier, we do not accrue revenue for approximately 5% - 10% of the tests that we perform and report as complete due principally to insufficient RNA from which to render a result and tests performed for which we do not reasonably expect to be paid.

Continued Adoption of and Reimbursement for our Products
 
  Revenue growth depends on our ability to secure coverage decisions, achieve broader reimbursement at increased levels from third-party payers, expand our base of prescribing physicians and increase our penetration in existing accounts. Because some payers consider our products experimental and investigational, we may not receive payment for tests and payments we receive may not be at acceptable levels. We expect our revenue growth to increase if more payers make a positive coverage decision and as payers enter into contracts with us, which should enhance our revenue and cash collections. To drive increased adoption of our products, we increased our sales force and marketing efforts over the last several years. Our sales team is structured to sell all of our products; we do not maintain a separate sales force for each product. If we are unable to expand the base of prescribing physicians and penetration within these accounts at an acceptable rate, or if we are not able to execute our strategy for increasing reimbursement, we may not be able to effectively increase our revenue. We expect to continue to see pressure from payers to limit the utilization of tests, generally, and we believe more payers are deploying cost containment tactics, such as pre-authorization, reduction of the payer portion of reimbursement and employing laboratory benefit managers to reduce utilization rates.

Integrating acquired assets and advances to our collaborations

Revenue growth, operational results and advances to our business strategy depends on our ability to integrate the assets acquired into our existing business. The integration of acquired assets may impact our revenue growth, increase the cost of operations, cause significant write-offs of intangible assets, or may require management resources that otherwise would be available for ongoing development of our existing business. The integration of assets acquired from NanoString in December
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2019 may impact our revenue and operating results through integration of a sales force, development of a product supply operation and the expansion of our business internationally with a broad menu of advanced genomic tests that may be offered.

Revenue growth or reimbursement from our collaborations depends on our ability to deliver services or information and achieve milestones required from our collaborative partners. Our collaboration partners pay us for the provision of data, other services and the achievement of milestones. Under a collaboration with Johnson & Johnson in 2018, we provided data services required under this agreement for $7.0 million in 2019, however, there remains $9.0 of revenue associated with development and commercialization milestones yet to be achieved.

How We Recognize Revenue
 
Testing Revenue

We recognize testing revenue in accordance with the provisions of ASC 606, Revenue from Contracts with Customers. Most of our revenue is generated from the provision of diagnostic testing services. These services are completed upon the delivery of test results to the prescribing physician, at which time we bill for the services. We recognize revenue related to billings on an accrual basis based on estimates of the amount that will ultimately be realized. In determining the amount to accrue for a delivered test, we consider factors such as payment history, payer coverage, whether there is a reimbursement contract between the payer and us, payment as a percentage of agreed upon rate (if applicable), amount paid per test and any current developments or changes that could impact reimbursement. These estimates require significant judgment by management.

Prior to the adoption of ASC 606, for our testing services we recognized a portion of our revenue not at the time of delivery of test results, on an accrual-basis of accounting, but upon the ultimate payment for those services, on the cash-basis of accounting. Through December 31, 2019, cumulative amounts billed at list price for tests processed which were not recognized as revenue upon delivery of a patient report because our accrual revenue recognition criteria were not met and for which we have not collected cash or written off as uncollectible, totaled approximately $159.3 million. Of this amount, we did not collect any amounts in the three months ended March 31, 2020 and we have no expectation of future collection because we began accruing for substantially all revenue upon delivery of a patient report in the third quarter of 2016. Under ASC 606, we recognize revenue at the time we deliver test results based upon what we reasonably expect to collect and the list price of a test may not be indicative of what we ultimately expect to collect.

Generally, cash we receive is collected within 12 months of the date the test is billed. We cannot provide any assurance as to when, if ever, or to what extent any of these amounts will be collected. Notwithstanding our efforts to obtain payment for these tests, payers may deny our claims, in whole or in part, and we may never receive payment for these tests.

We bill list price regardless of contract rate, but only recognize revenue from amounts that we estimate are collectible and meet our revenue recognition criteria. Revenue may not be equal to the billed amount due to a number of factors that we consider when determining revenue accrual rates, including differences in reimbursement rates, the amounts of patient co-payments and co-insurance, the existence of secondary payers, claims denials and the amount we expect to ultimately collect. Finally, when we increase our list price, it will increase the cumulative amounts billed but may not positively impact accrued revenue. In addition, payer contracts generally include the right of offset and payers may offset payments prior to resolving disputes over tests performed.

Generally, we calculate the average reimbursement from our products from all payers, for tests that are on average a year old, since it can take a significant period of time to collect from some payers. Except in situations where we believe the rate we reasonably expect to collect to vary due to a coverage decision, contract, more recent reimbursement data or evidence to the contrary, we use an average of reimbursement for tests provided over four quarters as it reduces the effects of temporary volatility and seasonal effects. Thus, the average reimbursement per product represents the total cash collected to date against genomic classifier tests, including variants, performed during the relevant period divided by the number of these tests performed during that same period.

The average Afirma genomic classifier reimbursement rate will change over time due to a number of factors, including medical coverage decisions by payers, the effects of contracts signed with payers, changes in allowed amounts by payers, our ability to successfully win appeals for payment, and our ability to collect cash payments from third-party payers and individual patients. Historical average reimbursement is not necessarily indicative of future average reimbursement. For the three months ended March 31, 2020, we accrued, on average, between $2,800 and $2,900 for the Afirma genomic classifier tests, including variants, that met our revenue recognition standard, which was between 90% - 95% of the reported Afirma classifier test volume.
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From the first quarter of 2019 to the first quarter of 2020, we accrued between $1.0 million and $2.4 million in revenue per quarter from providing cytopathology services associated with our Afirma solution.

We incur expense for tests in the period in which the test is conducted and recognize revenue for tests in the period in which our revenue recognition criteria are met.
 
Product Revenue

We began recognizing product revenue in December 2019 in accordance with the provisions of ASC 606, Revenue from Contracts with Customers, when we executed an agreement with NanoString for the exclusive worldwide license to the nCounter platform and the acquisition of products for in vitro diagnostic use.

We recognize product revenue when control of the promised goods is transferred to our customers, in an amount that reflects the consideration expected to be received in exchange for those products. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. Performance obligations are considered satisfied once we have transferred control of a product to the customer, meaning the customer has the ability to use and obtain the benefit of the product. We recognize product revenue for satisfied performance obligations only when there are no uncertainties regarding payment terms or transfer of control. Shipping and handling costs incurred for product shipments are charged to our customers and included in product revenue.

Our products consist of the Prosigna breast cancer assay, the nCounter FLEX Analysis System and related consumables. Revenues are presented net of the taxes that are collected from customers and remitted to governmental authorities.

 Biopharmaceutical and Collaboration Revenues

From time to time, we enter into arrangements to license or provide access to our assets or services, including testing services, clinical and medical services, research and development and other services. Such arrangements may require us to deliver various rights, data, services, access and/or testing services to leading biopharmaceutical companies. The underlying terms of these arrangements generally provide for consideration paid to us in the form of nonrefundable fees, performance milestone payments, expense reimbursements and possibly royalty and/or other payments.

The terms of our collaborative arrangements typically include one or more of the following: (i) up-front fees; (ii) milestone payments related to the achievement of development, regulatory, or commercial goals; and (iii) royalties on net sales of licensed products. Each of these payments may result in collaboration revenues or an offset against research and development expense.

Arrangements with partners may fall under the scope of ASC Topic 808, Collaborative Arrangements, or ASC 808. While these arrangements are in the scope of ASC 808, we may analogize to ASC 606 for some aspects of these arrangements. We analogize to ASC 606 for certain activities within the collaborative arrangement for the delivery to a customer of a good or service (i.e., a unit of account) that is part of our ongoing major or central operations.

In arrangements involving more than one performance obligation, each required performance obligation is evaluated to determine whether it qualifies as a distinct performance obligation based on whether (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available and (ii) the good or service is separately identifiable from other promises in the contract. The consideration under the arrangement is then allocated to each separate distinct performance obligation based on its respective relative stand-alone selling price. The estimated selling price of each deliverable reflects our best estimate of what the selling price would be if the deliverable was regularly sold by us on a stand-alone basis or using an adjusted market assessment approach if selling price on a stand-alone basis is not available.

The consideration allocated to each distinct performance obligation is recognized as revenue when control of the related goods is transferred or services are performed. Consideration associated with at-risk substantive performance milestones is recognized as revenue when it is probable that a significant reversal of the cumulative revenue recognized will not occur. Should there be royalties, we utilize the sales and usage-based royalty exception in arrangements that resulted from the license of intellectual property, recognizing revenues generated from royalties or profit sharing as the underlying sales occur.
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Net sales of data or other services to our customers are classified under biopharmaceutical revenue, and all other non-customer revenue, such as milestones, are classified under collaboration revenue in our consolidated statements of operations and comprehensive loss. Payments made to us that are not net sales of data or other services to our customers are recorded as an offset against research and development expense in our consolidated statements of operations and comprehensive loss.

Development of Additional Tests
 
We continue to advance our portfolio of diagnostic tests that leverage innovations in genomic science, sequencing technology, machine learning and leveraging our new nCounter Analysis System to further improve patient care globally.

In May 2017, we introduced the Afirma GSC, supported by rigorous clinical validation data showing that the RNA sequencing-based test can help significantly more patients avoid unnecessary surgery in thyroid cancer diagnosis, compared to the original Afirma classifier. The Afirma GSC and Xpression Atlas, originally launched in March 2018 with an expanded version launched in April 2020, provide physicians with a comprehensive solution for thyroid nodule diagnosis. The Afirma GSC was developed with RNA whole-transcriptome sequencing and machine learning and helps identify patients with benign thyroid nodules among those with indeterminate cytopathology results in order to help patients avoid unnecessary diagnostic thyroid surgery. For those with suspected thyroid cancer, the Afirma Xpression Atlas provides physicians with genomic alteration content from the same fine needle aspiration samples that are used in Afirma GSC testing and may help physicians decide with greater confidence on the surgical or therapeutic pathway for their patients.

The expanded Afirma XA test, launched in April 2020, provides physicians with additional gene alteration content – including novel or rare NTRK, ALK, RET and BRAF fusions to further inform surgery and treatment decisions for patients with suspected or confirmed thyroid cancer. The Afirma XA utilizes RNA sequencing on the same FNA sample used for Afirma GSC testing. Compared to the original gene alteration panel, the expanded Afirma XA now reports 905 DNA variants (versus 761) and 235 RNA fusion partners (versus 130) in 593 genes (versus 511).

Together with our Afirma GSC and our tests for the BRAF v600E mutation and medullary thyroid cancer, or Malignancy Classifiers, the Afirma XA rounds out a comprehensive solution for physicians evaluating thyroid nodules. This innovation also enables us to enter into research collaborations with biopharmaceutical companies, which is intended to support their development of targeted therapies for genetically defined cancers, including thyroid cancer.

We have also expanded our ability to provide important clinical answers - without the need for surgery - into pulmonology. Our Percepta Bronchial Genomic Classifier, introduced in April 2015, is the first genomic test to receive Medicare coverage for use in lung cancer diagnosis, where it improves the performance of diagnostic bronchoscopy. In June 2019, we began making our “next-generation” Percepta Genomic Sequencing Classifier available to physicians, providing them with expanded lung cancer risk information that can further guide next steps for patients with suspicious lung nodules, as compared to the Percepta Bronchial Genomic Classifier.

Additionally, our Envisia Genomic Classifier, launched in October 2016, is the first commercial test to improve the diagnosis of IPF among patients with a suspected interstitial lung disease. In March 2019, we received final Medicare coverage for the Envisia classifier through the MolDX program, with an effective date of April 1, 2019.

We also believe our Xpression Atlas platform can be transferred to our pulmonology indications, to further improve patient care and advance precision medicine in lung cancer and IPF.

We are currently exploring opportunities to utilize the same “field of injury” technology that powers our Percepta classifier to develop a nasal swab test that can enable earlier lung cancer detection - and ultimately help reduce lung cancer deaths. In October 2019, we announced preliminary clinical data for our noninvasive nasal swab classifier - the first test of its kind. The findings show that the novel genomic test can accurately classify lung cancer risk in patients with lung nodules so that these patients can obtain the prompt diagnosis and potential treatment they need or may be monitored noninvasively.
 
Timing of Our Research and Development Expenses
 
We deploy state-of-the-art and costly genomic technologies in our biomarker discovery experiments, and our spending on these technologies may vary substantially from quarter to quarter. We also spend a significant amount to secure clinical samples that can be used in discovery and product development as well as clinical validation studies. The timing of these research and development activities is difficult to predict, as is the timing of sample acquisitions. If a substantial number of clinical samples are acquired in a given quarter or if a high-cost experiment is conducted in one quarter versus the next, the
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timing of these expenses can affect our financial results. We conduct clinical studies to validate our new products as well as on-going clinical studies to further the published evidence to support our commercialized tests. As these studies are initiated, start-up costs for each site can be significant and concentrated in a specific quarter. Spending on research and development, for both experiments and studies, may vary significantly by quarter depending on the timing of these various expenses.


Financial Overview
 
Revenue
 
Through March 31, 2020, we had derived most of our revenue from the sale of Afirma, delivered primarily to physicians in the United States. We generally invoice third-party payers upon delivery of a patient report to the prescribing physician. As such, we take the assignment of benefits and the risk of cash collection from the third-party payer and individual patients. Third-party payers and other customers in excess of 10% of total revenue and their related revenue as a percentage of total revenue were as follows:
 
 Three Months Ended March 31,
 20202019
Medicare25 %21 %
Johnson and Johnson Services, Inc. 13 %
UnitedHealthcare11 %11 %
 36 %45 %
 
For tests performed, we recognize the related revenue upon delivery of a patient report to the prescribing physician based on the amount that we expect to ultimately receive. In determining the amount to accrue for a delivered test, we consider factors such as payment history, payer coverage, whether there is a reimbursement contract between the payer and us, payment as a percentage of agreed upon reimbursement rate (if applicable), amount paid per test and any current development or changes that could impact reimbursement. Upon ultimate collection, the amount received is compared to previous estimates and the amount accrued is adjusted accordingly. Our ability to increase our revenue will depend on our ability to penetrate the market, obtain positive coverage policies from additional third-party payers, obtain reimbursement and/or enter into contracts with additional third-party payers for our current and new tests, and increase reimbursement rates for tests performed. Finally, should the judgments underlying our estimated reimbursement change, our accrued revenue and financial results could be negatively impacted in future periods.

Cost of Revenue
 
The components of our cost of testing revenue are laboratory expenses, kit costs, sample collection expenses, compensation expense, license fees and royalties, depreciation and amortization, other expenses such as equipment and laboratory supplies, and allocations of facility and information technology expenses. Costs associated with performing tests are recorded as the test is processed regardless of whether and when revenue is recognized with respect to that test. As a result, our cost of revenue as a percentage of revenue may vary significantly from period to period because we may not recognize all revenue in the period in which the associated costs are incurred. We expect cost of revenue in absolute dollars to increase as the number of tests we perform increases. However, we expect that the cost per test will decrease over time due to leveraging fixed costs, efficiencies we may gain as test volume increases and from automation, process efficiencies and other cost reductions. As we introduce new tests, initially our cost of revenue will be high as we expect to run suboptimal batch sizes, run quality control batches, test batches, registry samples and generally incur costs that may suppress or reduce gross margins. This will disproportionately increase our aggregate cost of revenue until we achieve efficiencies in processing these new tests.

Our cost of product revenue consists primarily of costs of purchasing instruments and consumables from third-party contract manufacturers, installation, warranty, service and packaging and delivery costs. In addition, cost of product includes royalty costs for licensed technologies included in our products and labor expenses. As our Prosigna kits are sold in various configurations with different number of tests, our product cost per test will vary based on the specific kit configuration purchased by customers.

Our cost of biopharmaceutical revenue are the costs of performing activities under arrangements that require us to perform research and development services on behalf of a customer pursuant to a biopharmaceutical service agreement, and is mainly comprised of compensation expense and pass through costs.
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Research and Development
 
Research and development expenses include expenses incurred to develop our technology, collect clinical samples and conduct clinical studies to develop and support our products and pipeline. These expenses consist of compensation expenses, direct research and development expenses such as prototype materials, laboratory supplies and costs associated with setting up and conducting clinical studies at domestic and international sites, professional fees, depreciation and amortization, other miscellaneous expenses and allocation of facility and information technology expenses. We expense all research and development costs in the periods in which they are incurred. We expect to incur significant research and development expenses as we continue to invest in research and development activities related to developing additional products and evaluating various platforms. We incurred research and development expenses on ongoing evidence development for our Afirma, Percepta and Envisia classifiers in 2019. We incurred a majority of our research and development expenses in the three months ended March 31, 2020 in support of our pipeline products, and expect this to continue in the remainder of 2020 and beyond.
 
Selling and Marketing
 
Selling and marketing expenses consist of compensation expenses, direct marketing expenses, professional fees, other expenses such as travel and communications costs and allocation of facility and information technology expenses. We have expanded our internal sales force as we invest in our multi-product sales strategy to assign a single point of contact to successfully develop and implement relationships with our customers and increased our marketing spending. We have also incurred increased selling and marketing expense as a result of investments in our lung product portfolio and believe total selling and marketing expenses will continue to increase as we launch and promote our new tests.
 
General and Administrative
 
General and administrative expenses include compensation expenses for executive officers and administrative, billing and client service personnel, professional fees for legal and audit services, occupancy costs, depreciation and amortization, and other expenses such as information technology and miscellaneous expenses offset by allocation of facility and information technology expenses to other functions. For the three months ended March 31, 2020, approximately 68% of the average headcount classified as general and administrative encompass our billing and customer care teams. We expect general and administrative expenses to continue to increase as we build our general and administration infrastructure and to stabilize thereafter.
 
Intangible Asset Amortization
 
Our finite-lived intangible assets, acquired in business combinations, are being amortized over 5 to 15 years, using the straight-line method. Amortization expense is expected to be approximately $5.1 million per year through 2024 and decrease thereafter.
 
Interest Expense
 
Interest expense is attributable to our borrowings under debt agreements and capital leases as well as costs associated with the prepayment of debt.
 
Other Income, Net
 
Other income, net consists primarily of sublease rental income and interest income from our cash held in interest bearing accounts.
 
Results of Operations
 
Comparison of the three months ended March 31, 2020 and 2019 (in thousands of dollars, except percentages and genomic classifiers reported):
 
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 Three Months Ended March 31,
 20202019Change%
Revenue:
Testing revenue$26,991  $25,389  $1,602  6%
Product revenue3,409  —  3,409  NM
Biopharmaceutical revenue722  4,140  (3,418) (83)%
Total revenue31,122  29,529  1,593  5%
Operating expense:    
Cost of testing revenue10,568  8,513  2,055  24%
Cost of product revenue1,559  —  1,559  NM
Cost of biopharmaceutical revenue116  —  116  NM
Research and development4,407  3,435  972  28%
Selling and marketing17,584  12,477  5,107  41%
General and administrative7,813  6,904  909  13%
Intangible asset amortization1,275  267  1,008  378%
Total operating expenses43,322  31,596  11,726  37%
Loss from operations(12,200) (2,067) (10,133) 490%
Interest expense(55) (303) 248  (82)%
Other income, net539  453  86  19%
Net loss and comprehensive loss$(11,716) $(1,917) $(9,799) 511%
Other Operating Data:    
Genomic classifiers reported10,559  9,162  1,397  15%
Depreciation and amortization expense1,972  945  1,027  109%
Stock-based compensation expense2,905  1,759  1,146  65%
 
Revenue
 
During the second half of March 2020, we experienced a significant decline in the volume of samples received resulting in a significant decline in revenue due to COVID-19. In spite of this, revenue increased $1.6 million, or 5%, for the three months ended March 31, 2020 compared to the same period in 2019. This was primarily due to $3.4 million of sales of Prosigna, a product that we acquired the rights to from NanoString in December 2019, and a $1.6 million increase in testing revenue from a 15% increase in our Afirma, Percepta, and Envisia genomic classifiers reported. We also make adjustments, as necessary, for testing revenue accrued in prior periods as collections are made if the amount we expect to collect changes. The adjustment for testing revenue accrued in prior periods decreased revenue by $0.1 million and increased revenue by $0.6 million for the three months ended March 31, 2020 and 2019, respectively, a net decrease of $0.7 million between the periods. Biopharmaceutical revenue decreased $3.4 million, mainly due to the performance of data sequencing services for Johnson & Johnson in the prior year period that did not recur in the three months ended March 31, 2020.

Cost of revenue
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Comparison of the three months ended March 31, 2020 and 2019 is as follows (in thousands of dollars, except percentages):
 
 Three Months Ended March 31,
 20202019Change%
Cost of testing revenue:    
Laboratory costs$6,220  $4,664  $1,556  33%
Sample collection costs1,221  1,095