Genomic Health, Inc.
GENOMIC HEALTH INC (Form: 10-Q, Received: 05/10/2017 16:05:30)

Table of Contents  

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2017

 

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: 000-51541

 

GENOMIC HEALTH, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

 

77-0552594

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

301 Penobscot Drive

Redwood City, California 94063

(Address of principal executive offices, including Zip Code)

 

(650) 556-9300

(Registrant’s telephone number, including area code)

 

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 ☒ NO ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ☒ NO ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):

 

 

 

 

Large accelerated filer ☐

 

Accelerated filer ☒

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

 

 

 

Emerging growth company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

 

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. ☐

 

The number of outstanding shares of the registrant’s Common Stock, $0.0001 par value, was 34,342,231 as of April 30, 2017.

 

 

 

 


 

Table of Contents  

GENOMIC HEALTH, INC.

INDEX

 

 

 

 

 

 

 

 

    

    

    

Page

 

 

 

FINANCIAL INFORMATION

 

 

 

Item 1.  

 

Financial Statements (unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets

 

3

 

 

 

Condensed Consolidated Statements of Operations

 

4

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss)

 

5

 

 

 

Condensed Consolidated Statements of Cash Flows

 

6

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

Item 2.  

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

19

 

Item 3.  

 

Quantitative and Qualitative Disclosures about Market Risk

 

35

 

Item 4.  

 

Controls and Procedures

 

36

 

 

 

OTHER INFORMATION

 

36

 

Item 1A.  

 

Risk Factors

 

37

 

Item 6.  

 

Exhibits

 

56

 

Signatures  

 

 

 

56

 

 

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PART  1: FINANCIAL INFORMATIO N

 

Item 1. Financial Statement s

 

GENOMIC HEALTH, INC.

Condensed Consolidated Balance Sheet s

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

 

2017

 

2016

 

ASSETS

    

 

    

    

 

    

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

40,774

 

$

40,404

 

Short-term marketable securities

 

 

53,648

 

 

56,585

 

Accounts receivable (net of allowance for doubtful accounts; 2017—$3,724, 2016—$4,508)

 

 

34,593

 

 

35,179

 

Prepaid expenses and other current assets

 

 

13,079

 

 

13,796

 

Total current assets

 

 

142,094

 

 

145,964

 

Property and equipment, net

 

 

49,459

 

 

45,688

 

Other assets

 

 

10,321

 

 

9,462

 

Total assets

 

$

201,874

 

$

201,114

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

5,238

 

$

2,864

 

Accrued compensation and employee benefits

 

 

19,109

 

 

27,900

 

Accrued expenses and other current liabilities

 

 

12,137

 

 

10,180

 

Other current liabilities

 

 

281

 

 

231

 

Total current liabilities

 

 

36,765

 

 

41,175

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

3,941

 

 

3,834

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Common stock

 

 

 3

 

 

 3

 

Additional paid-in capital

 

 

434,191

 

 

427,102

 

Accumulated other comprehensive (loss) income

 

 

(22)

 

 

1,198

 

Accumulated deficit

 

 

(242,894)

 

 

(242,088)

 

    Treasury stock, at cost 

 

 

(30,110)

 

 

(30,110)

 

Total stockholders’ equity

 

 

161,168

 

 

156,105

 

Total liabilities and stockholders’ equity

 

$

201,874

 

$

201,114

 

 

See accompanying notes.

 

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GENOMIC HEALTH, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

Product revenues

 

$

83,979

 

$

80,894

 

Operating expenses:

 

 

 

 

 

 

 

Cost of product revenues

 

 

13,672

 

 

16,153

 

Research and development

 

 

14,874

 

 

15,610

 

Selling and marketing

 

 

41,507

 

 

39,500

 

General and administrative

 

 

16,751

 

 

18,438

 

Total operating expenses

 

 

86,804

 

 

89,701

 

Loss from operations

 

 

(2,825)

 

 

(8,807)

 

Interest income

 

 

158

 

 

78

 

Gain on sale of equity securities

 

 

2,807

 

 

1,333

 

Other income (expense), net

 

 

95

 

 

87

 

Income (loss) before income taxes

 

 

235

 

 

(7,309)

 

Income tax expense (benefit)

 

 

1,041

 

 

(958)

 

Net loss

 

$

(806)

 

$

(6,351)

 

Basic and diluted net loss per share

 

$

(0.02)

 

$

(0.19)

 

Shares used in computing basic and diluted net loss per share

 

 

34,009

 

 

32,900

 

 

See accompanying notes.

 

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GENOMIC HEALTH, INC.

Condensed Consolidated Statements of Comprehensive Incom e (Loss)

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

Net loss

    

$

(806)

 

$

(6,351)

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

Unrealized gain (loss) on available-for-sale marketable securities, net of tax expense of $0 and $1,358 for the three months ended March 31, 2017 and 2016, respectively

 

 

(94)

 

 

2,391

 

Reclassification adjustment for net gain on sale of equity securities included in net loss

 

 

(1,126)

 

 

(442)

 

Comprehensive loss

 

$

(2,026)

 

$

(4,402)

 

 

See accompanying notes.

 

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GENOMIC HEALTH, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

Operating activities

    

 

 

 

 

 

 

Net loss

 

$

(806)

    

$

(6,351)

 

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

2,407

 

 

2,179

 

Employee stock-based compensation

 

 

5,105

 

 

4,542

 

Impairment of assets held for sale and long-lived assets

 

 

 —

 

 

56

 

Gain on disposal of property and equipment

 

 

35

 

 

 —

 

Outside director restricted stock awarded in lieu of fees

 

 

50

 

 

50

 

Gain on sale of equity securities

 

 

(2,807)

 

 

(1,333)

 

Deferred tax benefit from unrealized gain on available-for-sale marketable securities, net

 

 

820

 

 

(1,107)

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

586

 

 

(1,665)

 

Prepaid expenses and other assets

 

 

717

 

 

(480)

 

Accounts payable

 

 

2,218

 

 

(2,441)

 

Accrued compensation and employee benefits

 

 

(8,791)

 

 

(2,181)

 

Accrued expenses and other liabilities

 

 

1,231

 

 

3,439

 

Deferred revenues

 

 

 —

 

 

(57)

 

Net cash provided by (used in) operating activities

 

 

765

 

 

(5,349)

 

Investing activities

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(5,144)

 

 

(5,311)

 

Proceeds from sale of property and equipment

 

 

10

 

 

 —

 

Purchases of marketable securities

 

 

(20,599)

 

 

(12,207)

 

Maturities of marketable securities

 

 

13,250

 

 

19,757

 

Proceeds from sales of marketable securities

 

 

10,155

 

 

3,579

 

Net cash (used in) provided by investing activities

 

 

(2,328)

 

 

5,818

 

Financing activities

 

 

 

 

 

 

 

Net proceeds from issuance of common stock under stock plans

 

 

6,069

 

 

632

 

Withholding taxes related to restricted stock units net share settlement

 

 

(4,136)

 

 

(2,929)

 

Net cash provided by (used in) financing activities

 

 

1,933

 

 

(2,297)

 

Net increase (decrease) in cash and cash equivalents

 

 

370

 

 

(1,828)

 

Cash and cash equivalents at the beginning of period

 

 

40,404

 

 

32,533

 

Cash and cash equivalents at the end of period

 

$

40,774

 

$

30,705

 

Non-cash investing and financing activities

 

 

 

 

 

 

 

Accrued purchases of property and equipment

 

$

2,486

 

$

291

 

Change in fair value of equity investment

 

$

 —

 

$

3,787

 

 

See accompanying notes.

 

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GENOMIC HEALTH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2017

(Unaudited)

 

Note 1. Organization and Summary of Significant Accounting Policies

 

The Company

 

Genomic Health, Inc. (the “Company”) is a global healthcare company that provides actionable genomic information to personalize cancer treatment decisions. The Company develops and globally commercializes genomic based clinical laboratory services that analyze the underlying biology of cancer, allowing physicians and patients to make individualized treatment decisions. The Company was incorporated in Delaware in August 2000. The Company’s first product, the Oncotype DX breast cancer test, was launched in 2004 and is used for early stage invasive breast cancer patients to predict the likelihood of breast cancer recurrence and the likelihood of chemotherapy benefit. In January 2010, the Company launched its second product, the Oncotype DX colon cancer test, which is used to predict the likelihood of colon cancer recurrence in patients with stage II disease. The tests for invasive breast and colon cancers result in a quantitative score referred to as a Recurrence Score. In December 2011, the Company made Oncotype DX available for patients with ductal carcinoma in situ (“DCIS”), a pre-invasive form of breast cancer. This test provides a DCIS Score that is used to predict the likelihood of local recurrence. In June 2012, the Company began offering the Oncotype DX colon cancer test for use in patients with stage III disease treated with oxaliplatin containing adjuvant therapy. In May 2013, the Company launched the Oncotype DX prostate cancer test, which provides a Genomic Prostate Score, or GPS, to predict disease aggressiveness in men with low risk prostate cancer disease. This test is used to improve treatment decisions for prostate cancer patients, in conjunction with the Gleason score, or tumor grading. In June 2016, the Company introduced Oncotype SEQ Liquid Select, the first of several planned non-invasive liquid biopsy tests that the Company plans to deliver as part of its Oncotype IQ Genomic Intelligence Platform.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements include all the accounts of the Company and its wholly-owned subsidiaries. The Company had two wholly-owned subsidiaries at March 31, 2017: Genomic Health International Holdings, LLC, which was established in Delaware in 2010 and supports the Company’s international sales and marketing efforts; and Oncotype Laboratories, Inc., which was established in 2012, and is inactive. Genomic Health International Holdings, LLC has nine wholly-owned subsidiaries. The functional currency for the Company’s wholly-owned subsidiaries incorporated outside the United States is the U.S. dollar. All significant intercompany balances and transactions have been eliminated.

 

Basis of Presentation and Use of Estimates

 

The accompanying interim period condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The condensed consolidated balance sheet as of March 31, 2017, condensed consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2017 and 2016, and condensed consolidated statements of cash flows for the three months ended March 31, 2017 and 2016 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 and cash flows for the periods presented. The condensed consolidated balance sheet at December 31, 2016 has been derived from audited financial statements, but it does not include certain information and notes required by GAAP for complete consolidated financial statements.

 

The preparation of financial statements in conformity with GAAP requires management to make judgments, assumptions and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures in the Company’s condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

 

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The accompanying interim period condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

There have been no material changes in the Company’s significant accounting policies, other than the adoption of Accounting Standards Update ("ASU") 2016-09 described below, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

Certain reclassifications have been made to prior period amounts to conform to the current period presentation. For the three months ended March 31, 2016, a reclassification of certain expenses from research and development to cost of product revenue was made in the condensed consolidated statements of operations to conform to the current period presentation.

 

Revenue Recognition

 

The Company derives its revenues from product sales and, to a lesser extent from contracts with biopharmaceutical and pharmaceutical companies. The majority of the Company’s historical product revenues have been derived from the sale of the Oncotype DX breast cancer test. The Company generally bills third-party payors upon generation and delivery of a patient report to the physician. As such, the Company takes assignment of benefits and the risk of collection with the third-party payor. The Company generally bills the patient directly for amounts owed after multiple requests for payment have been denied or only partially paid by the insurance carrier. The Company pursues case-by-case reimbursement where medical policies are not in place or payment history has not been established.

 

The Company’s product revenues for tests performed are recognized when the following revenue recognition criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Criterion (1) is satisfied when the Company has an arrangement to pay or a contract with the payor in place addressing reimbursement for the Oncotype test. In the absence of such arrangements, the Company considers that criterion (1) is satisfied when a third-party payor pays the Company for the test performed. Criterion (2) is satisfied when the Company performs the test and generates and delivers to the physician, or makes available on its web portal, a patient report. When evaluating whether the fee is fixed or determinable and collectible, the Company considers whether it has sufficient history to reliably estimate the total fee that will be received from a payor and a payor’s individual payment patterns. Determination of criteria (3) and (4) are based on management’s judgments regarding whether the fee charged for products or services delivered is fixed or determinable, and the collectability of those fees under any contract or arrangement. Based upon at least several months of payment history, the Company reviews the number of tests paid against the number of tests billed and the payor’s outstanding balance for unpaid tests to determine whether payments are being made at a consistently high percentage of tests billed and at appropriate amounts given the arrangement or contracted payment amount. The estimated accrual amounts per test, recorded upon delivery of a patient report, are calculated for each accrual payor and are based on the arrangement or contracted price adjusted for individual payment patterns resulting from co-payment amounts and excluded services in healthcare plans. The Company also reduces revenue for an estimate of amounts that qualify as patient assistance and related deductions that do not qualify for revenue recognition. When a payment received for an individual test is higher or lower than the estimated accrual amount, the Company recognizes the difference as either cash revenue, in the case of higher payments, or in the case of lower payments, a charge against either the patient assistance program and related deductions reserve or the allowance for doubtful accounts, as applicable.

 

To the extent all criteria set forth above are not met when test results are delivered, product revenues are recognized when cash is received from the payor.

 

The Company has exclusive distribution agreements for one or more of its Oncotype tests with distributors covering more than 90 countries outside of the United States. The distributor generally provides certain marketing and administrative services to the Company within its territory. As a condition of these agreements, the distributor generally pays the Company an agreed upon fee per test and the Company processes the tests. The same revenue recognition criteria described above generally apply to tests received through distributors. To the extent all criteria set forth above

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are not met when test results are delivered, product revenues are generally recognized when cash is received from the distributor.

 

From time to time, the Company receives requests for refunds of payments, generally due to overpayments made by third-party payors. Upon becoming aware of a refund request, the Company establishes an accrued liability for tests covered by the refund request until such time as the Company determines whether or not a refund is due. Accrued refunds were $390,000 and $487,000 at March 31, 2017 and December 31, 2016, respectively, and are included in accrued expenses and other current liabilities.

 

Contract revenues are generally derived from studies conducted with biopharmaceutical and pharmaceutical companies. The specific methodology for revenue recognition is determined on a case-by-case basis according to the facts and circumstances applicable to a given contract. Under certain contracts, the Company’s input, measured in terms of full time equivalent level of effort or running a set of assays through its clinical reference laboratory under a contractual protocol, triggers payment obligations, and revenues are recognized as costs are incurred or assays are processed. Certain contracts have payments that are triggered as milestones are completed, such as completion of a successful set of experiments. Milestones are assessed on an individual basis and revenue is recognized when these milestones are achieved, as evidenced by acknowledgment from collaborators, provided that (1) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement and (2) the milestone payment is non-refundable. Where separate milestones do not meet these criteria, the Company typically defaults to a performance based model, such as revenue recognition following delivery of effort as compared to an estimate of total expected effort.

 

Advance payments received in excess of revenues recognized are classified as deferred revenue until such time as the revenue recognition criteria have been met.

 

Allowance for Doubtful Accounts

 

The Company accrues an allowance for doubtful accounts against its accounts receivable based on estimates consistent with historical payment experience. Bad debt expense is included in general and administrative expense on the Company’s consolidated statements of operations. Accounts receivable are written off against the allowance when the appeals process is exhausted, when an unfavorable coverage decision is received or when there is other substantive evidence that the account will not be paid. The Company’s allowance for doubtful accounts as of March 31, 2017 and December 31, 2016 was $3.7 million and $4.5 million, respectively. Write-offs for doubtful accounts of $1.3 million and $2.4 million were recorded against the allowance during the three months ended March 31, 2017 and 2016, respectively. Bad debt expense was $412,000 and $2.3 million for the three months ended March 31, 2017 and 2016, respectively.

 

Marketable Securities

 

The Company invests in marketable securities, primarily money market funds, obligations of U.S. Government agencies and government sponsored entities, corporate bonds, commercial paper and equity securities. The Company considers all investments with a maturity date of less than one year as of the balance sheet date to be short term investments. Those investments with a maturity date greater than one year as of the balance sheet date are considered to be long term investments.

 

During the three months ended March 31, 2017, the Company sold its remaining shares of the common stock of Invitae Corporation for net proceeds of $10.2 million based on a cost of $6.28 per share, resulting in a realized gain of $2.8 million. During the three months ended March 31, 2016, the Company sold a portion of its shares of the common stock of Invitae Corporation for net proceeds of $3.6 million at the cost of $6.28 per share, resulting in a realized gain of $1.3 million. The fair value of the remaining investment was $18.9 million at March 31, 2016. This investment, which was accounted for under the cost method, was valued at $11.6 million at March 31, 2016. Unrealized gains or losses resulting from changes in the fair value of this investment were recorded in other comprehensive income until the securities are sold. During the three months ended March 31, 2017 and 2016, $1.1 million and $442,000, respectively, of unrealized gain, net of tax of $821,000 and $251,000, respectively, related to the shares sold was reclassified out of accumulated other comprehensive income into earnings.

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As of March 31, 2017 and December 31, 2016, respectively, all investments in marketable securities were classified as available for sale. These securities are carried at estimated fair value with unrealized gains and losses included in stockholders’ equity.

 

Realized gains and losses and declines in value, if any, judged to be other than temporary on available for sale securities are reported in other income or expense. When securities are sold, any associated unrealized gain or loss initially recorded as a separate component of stockholders’ equity is reclassified out of accumulated other comprehensive income on a specific identification basis and recorded in earnings for the period. The cost of securities sold is determined using specific identification.

 

Investments in Privately Held Companies

 

The Company determines whether its investments in privately held companies are debt or equity based on their characteristics, in accordance with the applicable accounting guidance for such investments. The Company also evaluates the investee to determine if the entity is a variable interest entity (“VIE”) and, if so, whether the Company is the primary beneficiary of the VIE, in order to determine whether consolidation of the VIE is required in accordance with accounting guidance for consolidations. If consolidation is not required and the Company owns less than 50.1% of the voting interest of the entity, the investment is evaluated to determine if the equity method of accounting should be applied. The equity method applies to investments in common stock or in substance common stock where the Company exercises significant influence over the investee, typically represented by ownership of 20% or more of the voting interests of an entity. If the equity method does not apply, investments in privately held companies determined to be equity securities are accounted for using the cost method. Investments in privately held companies determined to be debt securities are accounted for as available for sale or held to maturity securities, in accordance with the applicable accounting guidance for such investments.

 

During the three months ended March 31, 2017 and the year December 2016, the Company invested $1.4 million and $6.1 million, respectively, in subordinated convertible promissory notes of a private company (see Note 4). On March 8, 2017, all of the Company’s investment in subordinated convertible promissory notes was converted into preferred stock of the private company representing approximately 9% of the entity’s voting interests, at which time the Company estimated the fair value of the subordinated convertible promissory notes to be approximately $7.1 million. The preferred stock represents a variable interest in the investee. The Company has concluded it is not the primary beneficiary and thus has not consolidated the investee pursuant to the requirements of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810. However, the Company will continue to assess its investment and future commitments to the investee and to the extent its relationship with the investee changes, may be required to consolidate the investee in future periods. The Company determined that the investment is an equity investment for which the Company does not have the ability to exercise significant influence. The equity investments are accounted for using the cost method of accounting and recorded in other assets on the Company’s condensed consolidated balance sheets. 

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09 , Revenue from Contracts with Customers (Topic 606) . Topic 606 supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, Revenue Recognition, and requires entities to recognize revenue when they transfer control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Topic 606 will be effective for the Company in the first quarter of 2018, with the option to adopt it in the first quarter of 2017. The Company intends to adopt Topic 606 effective January 1, 2018. Topic 606 permits the use of either a retrospective or modified retrospective application. The Company intends to use the modified retrospective approach. Upon adoption, the Company will recognize the cumulative effect of adopting this guidance as an adjustment to its opening accumulated deficit balance. Prior periods will not be retrospectively adjusted. Under Topic 606, the Company expects the timing of revenue recognition from certain payors who are not currently accrual payors to be accelerated. The Company is in the process of completing its analysis of the impact Topic 606 will have on its consolidated financial statements and related disclosures.

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In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . This ASU changes accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments. In addition, it clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will become effective for the Company beginning in the first quarter of 2018. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this ASU will have on its consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU No. 2016-2, Leases (Topic 842) . Topic 842 generally requires entities to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. Topic 842 is effective for the Company’s interim and annual reporting periods during the year ending December 31, 2019, and all annual and interim reporting periods thereafter. Early adoption is permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, and there are certain optional practical expedients that an entity may elect to apply. Full retrospective application is prohibited and early adoption by public entities is permitted. The Company is currently evaluating the impact that the adoption of Topic 842 will have on its consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting , which simplifies several aspects of the accounting for share-based payments, including immediate recognition of all excess tax benefits and deficiencies in the income statement, changing the threshold to qualify for equity classification up to the employees' maximum statutory tax rates, allowing an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur, and clarifying the classification on the statement of cash flows for the excess tax benefit and employee taxes paid when an employer withholds shares for tax-withholding purposes. The standard is effective for interim and annual reporting periods beginning after December 15, 2016, although early adoption is permitted. The Company adopted this ASU in the first quarter of 2017 and elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. As a result, in the first quarter of 2017, the Company recorded an $11.6 million cumulative-effect adjustment decrease in accumulated deficit and an offsetting increase in deferred tax assets for previously unrecognized excess tax benefits that existed as of December 31, 2016. However, as all of the Company’s deferred tax assets, net of deferred tax liabilities, are subject to a valuation allowance and the realization of these assets is not more likely than not to be achieved, the Company recorded an $11.6 million valuation allowance against these deferred tax assets with an offsetting increase in accumulated deficit. The presentation requirement for cash flows related to employee taxes paid for withheld shares will not impact the statements of cash flows since such cash flows have historically been presented as a financing activity. The adoption was on a prospective basis and therefore had no impact on prior periods.

 

Note 2.  Net Loss Per Share

 

Basic net loss per share is calculated by dividing net loss for the period by the weighted-average number of common shares outstanding for the period without consideration of potential common shares. Diluted net loss per share is calculated by dividing net loss by the weighted-average number of common shares outstanding for the period and dilutive potential common shares for the period determined using the treasury-stock method. For purposes of this calculation, options to purchase common stock and restricted stock unit (“RSU”) awards are considered to be potential common shares and are not included in the calculation of diluted net loss per share because their effect is anti-dilutive.

 

The following potentially dilutive common shares were excluded from the computation of diluted net loss per share for the periods presented because they would have been anti-dilutive:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Options and RSUs excluded from the computation

 

 

758

    

 

800

    

 

 

 

 

 

 

 

 

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Note 3.  Fair Value Measurements

 

Fair Value Hierarchy

 

The Company measures certain financial assets, including cash equivalents and marketable securities, at their fair value on a recurring basis. The fair value of these financial assets was determined based on a hierarchy of three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

 

Level 1:   Quoted prices in active markets for identical assets or liabilities;

 

Level 2:   Observable inputs other than Level 1 inputs, 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 3:   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

 

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. The Company did not have any non-financial assets or liabilities that were measured or disclosed at fair value on a recurring basis at either March 31, 2017 or December 31, 2016. The following tables set forth the Company’s financial instruments that were measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016 by level within the fair value hierarchy:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Actively Quoted

 

Significant

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

Balance at

 

 

Assets

 

Inputs

 

Inputs

 

March 31,

 

 

Level 1

 

Level 2

 

Level 3

 

2017

 

 

(In thousands)

As of March 31, 2017:

    

 

    

    

 

    

    

 

    

    

 

    

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Money market deposits

 

$

12,731

    

$

 —

    

$

 —

    

$

12,731

Commercial paper

 

 

 —

 

 

45,042

 

 

 —

 

 

45,042

Corporate debt securities

 

 

 —

 

 

9,504

 

 

 —

 

 

9,504

Total

 

$

12,731

 

$

54,546

 

$

 —

 

$

67,277

 

 

 

 

 

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Actively Quoted

 

Significant

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

Balance at

 

 

Assets

 

Inputs

 

Inputs

 

December 31,

 

 

Level 1

 

Level 2

 

Level 3

 

2016

 

 

(In thousands)

As of December 31, 2016:

    

 

    

    

 

    

    

 

    

    

 

    

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Money market deposits

 

$

13,198

    

$

 —

    

$

 —

    

$

13,198

Commercial paper

 

 

 —

 

 

32,421

 

 

 —

 

 

32,421

Corporate debt securities

 

 

 —

 

 

14,869

 

 

 —

 

 

14,869

Corporate equity securities

 

 

 —

 

 

9,295

 

 

 —

 

 

9,295

Total

 

$

13,198

 

$

56,585

 

$

 —

 

$

69,783

 

The Company’s commercial paper and corporate bonds are classified as Level 2 as they are valued using multi-dimensional relational pricing models that use observable market inputs, including benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. Not all inputs listed are available for use in the evaluation process on any given day for each security evaluation. In addition, market indicators and industry and economic events are monitored and may serve as a trigger to acquire further corroborating market data. The Company’s corporate equity securities are classified as Level 2 while subject to certain restrictions on sale.

 

During the year ended December 31, 2016, the Company invested $6.1 million in subordinated convertible promissory notes of a private company. As of December 31, 2016, the Company estimated the fair value of the subordinated convertible promissory notes to be approximately $5.8 million, which is not included in the table above and recorded in other assets. The subordinated convertible promissory notes were classified as Level 3 as they are valued using unobservable inputs that are primarily based on the Company’s estimate of the fair value of the underlying preferred stock into which the notes are convertible. In March 2017, the subordinated convertible promissory notes were converted into preferred stock of the privately company. The Company accounted for such preferred stock using the cost method of accounting and recorded in other assets on its condensed consolidated balance sheets.

 

All of the Company’s marketable securities are classified as available-for-sale. The following tables illustrate the Company’s available-for-sale marketable securities as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2017

 

 

Cost or

 

Gross

 

Gross

 

Total

 

 

Amortized

 

Unrealized

 

Unrealized

 

Estimated

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

(In thousands)

Commercial paper

    

$

45,065

    

$

 1

    

$

(23)

    

$

45,043

Corporate debt securities

 

 

9,503

 

 

 2

 

 

(2)

 

 

9,503

Total

 

$

54,568

 

$

 3

 

$

(25)

 

$

54,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

Cost or

 

Gross

 

Gross

 

Total

 

 

Amortized

 

Unrealized

 

Unrealized

 

Estimated

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

(In thousands)

Commercial paper

    

$

32,350

    

$

71

    

$

 —

    

$

32,421

Corporate debt securities

 

 

14,868

 

 

 3

 

 

(2)

 

 

14,869

Corporate equity securities

 

 

7,348

 

 

1,947

 

 

 —

 

 

9,295

Total

 

$

54,566

 

$

2,021

 

$

(2)

 

$

56,585

 

The Company realized gains of $2.8 million and $1.3 million on available-for-sale marketable securities for the three months ended March 31, 2017 and 2016, respectively.

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The following table summarizes the Company’s portfolio of available-for-sale marketable securities by contractual maturity as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2017

 

December 31, 2016

 

 

 

Amortized

 

Estimated

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

 

 

(In thousands)

 

Due in one year or less

    

$

53,670

    

$

53,648

    

$

54,566

    

$

56,585

 

Due in more than one year but less than five years

 

 

898

 

 

898

 

 

 —

 

 

 —

 

Total

 

$

54,568

 

$

54,546

 

$

54,566

 

$

56,585

 

 

 

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

 

The Company reviews the fair value of long-lived assets, which include property and equipment, intangible assets and investments in privately held companies, for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable. There were no impairments recorded during the three months ended March 31, 2017 and 2016.

 

 

Note 4. Collaboration and Commercial Technology Licensing Agreements

 

The Company has entered into a variety of collaboration and specimen transfer agreements relating to its development efforts. The Company recorded collaboration expenses of $935,000 and $938,000 for the three months ended March 31, 2017 and 2016, respectively, relating to services provided in connection with these agreements. In addition to these expenses, some of the agreements contain provisions for royalties from inventions resulting from the collaborations.

 

The Company is a party to various agreements under which it licenses technology on a non-exclusive basis in the field of human diagnostics. Access to these licenses enables the Company to process its Oncotype tests. While certain agreements contain provisions for fixed annual payments, license fees are generally calculated as a percentage of product revenues, with rates that vary by agreement and may be tiered, and payments that may have annual minimum or maximum amounts. The Company recognized costs recorded under these agreements totaling $95,000 and $2.5 million for the three months ended March 31, 2017 and 2016, respectively, which were included in cost of product revenues. The decrease in costs for these agreements for the three months ended March 31, 2017 compared to the same period in 2016, was primarily due to the satisfaction of certain royalty payment obligations. On October 28, 2016, the Company provided notice of termination of a license agreement with Roche Molecular Systems, Inc. (“Roche”), whereby the Company non-exclusively licensed from Roche a number of U.S. patents claiming nucleic acid amplification processes known as polymerase chain reaction (“PCR”), homogeneous polymerase chain reaction, and reverse transcription polymerase chain reaction (“RT-PCR”). The effective date of the termination was November 27, 2016. The Company believes it has satisfied all obligations to make royalty payments to Roche.

 

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In June 2016, the Company entered into a collaboration agreement with Epic Sciences, Inc. (“Epic Sciences”), under which the Company was granted exclusive rights to commercialize in the United States a test developed by Epic Sciences, which test we refer to as Oncotype DX AR-V7 Nucleus Detect. The Company has primary responsibility, in accordance with applicable laws and regulations, for marketing and promoting the test, order fulfillment, billing and collections of receivables, customer support, and providing order management systems for Oncotype DX AR-V7 Nucleus Detect. Epic Sciences is responsible for performing test analysis, performing studies, including analytic and clinical validation studies, and seeking Medicare coverage from the Centers for Medicare and Medicaid Services (“CMS”) for the test at a certain minimum rate. The collaboration agreement has a term of 10 years, unless terminated earlier under certain circumstances. As of March 31, 2017, the Company had invested $7.5 million in subordinated convertible promissory notes of Epic Sciences that converted into shares of Epic Sciences’ preferred stock in March 2017. The subordinated convertible promissory notes had been recognized at fair value, which the Company believed was approximately $7.1 million while the difference of $375,000 has been deferred and will be recognized as additional cost of future expected purchases of Oncotype DX AR-V7 Nucleus Detect tests, which the Company believes will be at a discount to fair value as of March 31, 2017. Upon achievement of an additional milestone, the Company has agreed to invest an additional $2.5 million in Epic Sciences’ preferred stock. Future revenues generated from Oncotype DX AR-V7 Nucleus Detect will be shared by the Company and Epic Sciences in accordance with the terms of the agreement. Additional terms of the agreement include the Company’s obligation to pay Epic Sciences $4.0 million in cash upon achievement of certain milestones.

 

The Company is required to make a series of fixed annual payments under a collaboration agreement beginning with the one year anniversary of achieving a key milestone for the Company’s DCIS clinical study in June 2014. As of March 31, 2017, a final payment of $504,000 is due in 2017.

 

Note 5. Commitments and Contingencies

 

Lease Obligations

 

The Company has entered into non-cancellable operating leases for laboratory and office facilities. Rental expense under operating lease agreements was $1.6 million for the three months ended March 31, 2017 and $1.3 million for the three months ended March 31, 2016.

 

Future non‑cancelable commitments under these operating leases at March 31, 2017 were as follows:

 

 

 

 

 

 

    

Annual

 

 

Payments

 

 

(In thousands)

Years Ending December 31,

 

 

 

2017 (remainder of year)

 

$

3,924

2018

 

 

5,953

2019

 

 

6,741

2020

 

 

7,070

2021

 

 

4,820

2022 and thereafter

 

 

5,117

Total minimum payments

 

$

33,625

 

Contingencies

From time to time, the Company may be subject to various legal proceedings and claims 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 consolidated financial statements. An estimated loss contingency is accrued in the consolidated financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

 

 

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Note 6. Stock-Based Compensation

 

On September 8, 2005, the Board of Directors approved the 2005 Stock Incentive Plan (the “2005 Plan”), which was later approved by the Company’s stockholders. Pursuant to the 2005 Plan, stock options, restricted shares, stock units, including RSUs, and stock appreciation rights may be granted to employees, consultants, and outside directors of the Company. Options granted may be either incentive stock options or nonstatutory stock options. The Company initially reserved 5,000,000 shares of common stock for issuance under the 2005 Plan, effective upon the closing of the Company’s initial public offering on October 4, 2005. On June 8, 2009, the Company’s stockholders approved an amendment to the 2005 Plan to increase the shares reserved for issuance under the 2005 Plan by 3,980,000 shares. The amended and restated plan also extends the term under which awards may be granted under the 2005 Plan until January 27, 2019. On June 11, 2015, the Company’s stockholders approved an amendment to the amended and restated 2005 Plan to increase the shares reserved for issuance under the 2005 Plan by 1,500,000 shares. On June 9, 2016, the Company’s stockholders approved an amendment to the amended and restated 2005 Plan to increase the shares reserved for issuance under the 2005 Plan by 1,500,000 shares.

 

Stock Options

 

A summary of the stock option activity under the 2005 Plan for the three months ended March 31, 2017 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding Options

 

 

 

Number of

 

Weighted-Average

 

 

 

Shares

 

Exercise Price

 

 

 

(In thousands)

 

 

 

Balance at December 31, 2016

 

3,606

 

$

25.07

 

Options granted

 

624

 

$

27.48

 

Options exercised

 

(290)

 

$

20.91

 

Options forfeited

 

(15)

 

$

28.67

 

Options expired

 

(3)

 

$

20.48

 

Balance at March 31, 2017

 

3,922

 

$

25.75

 

Exercisable at March 31, 2017

 

2,540

 

$

24.58

 

Vested and expected to vest at March 31, 2017

 

3,803

 

$

25.69

 

 

Restricted Stock Units

 

A summary of the RSU activity under the 2005 Plan for the three months ended March 31, 2017 is as follows:

 

 

 

 

 

 

 

 

    

 

    

Weighted-Average

 

 

Number of

 

Grant Date Fair

 

 

Shares

 

Value

 

 

(In thousands)

 

 

 

Balance at December 31, 2016

 

871

 

$

28.42

RSUs granted

 

523

 

$

27.88

RSUs vested

 

(330)

 

$

28.76

RSUs cancelled

 

(22)

 

$

28.23

Balance at March 31, 2017

 

1,042

 

$

28.04

 

 

Restricted Stock in Lieu of Directors’ Fees

 

Outside members of the Company’s Board of Directors may elect to receive fully-vested restricted stock in lieu of cash compensation for services as a director. During the three months ended March 31, 2017, the Company issued 1,700 shares of restricted stock to outside directors, with a grant date fair value of $50,000 and a weighted-average grant date fair value of $29.39 per share.

 

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Employee Stock Purchase Plan

 

A total of 1,250,000 shares of common stock have been reserved for issuance under the Employee Stock Purchase Plan (“ESPP”), of which 329,593 shares were available for issuance as of March 31, 2017. Shares are issued twice yearly at the end of each offering period. There were no shares issued during the three months ended March 31, 2017 or 2016. As of March 31, 2017, there was $253,000 of unrecognized compensation expense related to the ESPP, which is expected to be recognized over a period of two months.

 

Employee Stock-Based Compensation Expense

 

Share-based compensation expense recognized and included in the condensed consolidated statements of operations and comprehensive income (loss) was allocated as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Cost of product revenues

 

$

191

    

$

176

 

Research and development

 

 

1,389

 

 

1,237

 

Selling and marketing

 

 

1,511

 

 

1,438

 

General and administrative

 

 

2,014

 

 

1,691

 

Total

 

$

5,105

 

$

4,542

 

 

 

 

 

Note 7. Segment Information

 

The Company operates in one business segment, which primarily focuses on the development and global commercialization of genomic based clinical laboratory services that analyze the underlying biology of cancer, allowing physicians and patients to make individualized treatment decisions. The Company’s Oncotype DX breast, colon and prostate cancer tests have similar economic and other characteristics, including the nature of the products and production processes, type of customers, distribution methods and regulatory environment. As of March 31, 2017, the majority of the Company’s product revenues have been derived from sales of one product, the Oncotype DX breast cancer test.

 

The following table summarizes total revenue from customers by geographic region. Product revenues are attributed to countries based on ship-to location.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

United States

 

$

70,587

 

$

70,495

 

Outside of the United States

 

 

13,392

 

 

10,399

 

Total revenues

 

$

83,979

 

$

80,894

 

 

 

 

Note 8. Income Taxes

 

The Company recognized an income tax expense of $1.0 million and income tax benefit of $1.0 million for the three months ended March 31, 2017 and 2016, respectively, which was computed using the “discrete” (or “cut-off”) method. The income tax expense and income tax benefit for the three months ended March 31, 2017 and March 31, 2016 was primarily comprised of the intraperiod tax allocation of the deferred tax impact for available-for-sale marketable securities and foreign income tax expense.

 

Based on all available objective evidence, the Company believes that it is still more likely than not that its net deferred tax assets will not be fully realized. Accordingly, the Company maintains a valuation allowance against all of its

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net deferred tax assets as of both March 31, 2017 and December 31, 2016. The Company will continue to maintain a full valuation allowance until there is sufficient evidence to support recoverability of its deferred tax assets.

 

The Company had $2.2 million and $2.1 million of unrecognized tax benefits at March 31, 2017 and December 31, 2016, respectively. The Company does not anticipate a material change to its unrecognized tax benefits over the next 12 months that would affect its effective tax rate. Unrecognized tax benefits may change during the next 12 months for items that arise in the ordinary course of business.

 

Accrued interest and penalties related to unrecognized tax benefits are recognized as part of the Company’s income tax provision in its condensed consolidated statements of operations. The statute of limitations remain open for the years 2001 through 2017 in U.S. federal and state jurisdictions, and for the years 2011 through 2017 in foreign jurisdictions.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSI S OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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,” and similar expressions are intended to identify forward looking statements. These are statements that relate to future periods and include statements about our expectation that, for the foreseeable future, a significant amount of our revenues will be derived from our Oncotype DX invasive breast cancer test; the factors that may impact our financial results; our ability to achieve sustained profitability; our business strategy and our ability to achieve our strategic goals; our expectations regarding product revenues and the sources of those revenues; the amount of future revenues that we may derive from Medicare patients or categories of patients; our belief that we may become more dependent on Medicare reimbursement in the future; our plans to pursue reimbursement on a case-by-case basis; our ability, and expectations as to the amount of time it will take, to achieve reimbursement from third-party payors and government insurance programs for new indications of tests, new tests or in new markets; the potential impact of changes in reimbursement levels for our tests; our expectations regarding our international expansion and opportunities; the potential effects of foreign currency exchange rate fluctuations; our beliefs with respect to the benefits and attributes of our tests or tests we may seek to develop or collaborate on in the future; the factors we believe drive demand for our tests and our ability to sustain or increase such demand; our success in increasing patient and physician demand as a result of our direct sales approach and our salesforces’ capacity to sell our tests; plans for, and the timeframe for the development or commercial launch of future tests, test enhancements or new technologies; the factors that we believe will drive reimbursement and the establishment of coverage policies; the capacity of our clinical reference laboratory to process tests and our expectations regarding capacity; our dependence on collaborative relationships to develop tests and the success of those relationships; whether any tests will result from our collaborations or license agreements; the applicability of clinical results to actual outcomes; our estimates and assumptions with respect to disease incidence and potential market opportunities; the occurrence, timing, outcome or success of clinical trials or studies; our expectations regarding timing of the announcement or publication of research results; the benefits of our technology platform; the economic benefits of our tests to the healthcare system; the ability of our tests to impact treatment decisions; our beliefs regarding our competitive position; our expectations regarding new and future technologies, including next generation sequencing and non-invasive test technology, and their potential benefits; our belief that multi gene analysis provides superior analytical information; our beliefs regarding the benefits of genomic analysis in various patient populations; our expectations regarding our research and development, general and administrative and sales and marketing expenses and our anticipated uses of our funds; our expectations regarding capital expenditures; our ability to comply with the requirements of being a public company; our expectations regarding future levels of bad debt expense and billing and collections fees; our ability to attract and retain experienced personnel; the adequacy of our product liability insurance; our anticipated cash needs and our estimates regarding our capital requirements; our expected future sources of cash; our compliance with federal, state and foreign regulatory requirements; the potential impact resulting from the regulation of our tests by the U.S. Food and Drug Administration, or FDA, and other similar non-U.S. regulators; our belief that our tests are properly regulated under the Clinical Laboratory Improvement Amendments of 1988, or CLIA; the impact of new or changing policies, regulation or legislation, or of judicial decisions, on our business and reimbursement for our tests; the impact of seasonal fluctuations on our business; our belief that we have taken reasonable steps to protect our intellectual property; the impact of changing interest rates; our beliefs regarding unrecognized tax benefits or our valuation allowance; the impact of accounting pronouncements and our critical accounting policies, judgments, estimates, models and assumptions on our financial results; the impact of the economy on our business, patients and payors; and anticipated trends and challenges in our business and the markets in which we operate.

 

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, those risks discussed in Item 1A of this report, as well as our ability to develop and commercialize new products and product enhancements; the risk of unanticipated delays in research and development efforts; the risk that we may not obtain or maintain reimbursement for our existing tests or any future tests we may develop; the risk that reimbursement pricing or coverage may change; the risks and uncertainties associated with the regulation of our tests by the FDA or regulatory agencies outside of the U.S.; the success of our new technology; the results of clinical studies; the applicability of clinical results to actual outcomes; the impact of new legislation or regulations, or of judicial decisions, on our business; our ability to compete against

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third parties; our ability to obtain capital when needed; the economic environment; and our history of operating losses. 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.

 

In this report, all references to “Genomic Health,” “we,” “us,” or “our” mean Genomic Health, Inc.

 

Genomic Health, the Genomic Health logo, Oncotype, Oncotype DX, Recurrence Score, DCIS Score, Oncotype SEQ, Oncotype IQ, Oncotype DX AR-V7 Nucleus Detect   and Genomic Intelligence Platform are trademarks or registered trademarks of Genomic Health, Inc. We also refer to trademarks of other corporations and organizations in this report.

 

Business Overview

 

We are a global healthcare company that provides clinically-actionable genomic information to personalize cancer treatment. We develop and globally commercialize genomic-based clinical laboratory services that analyze the underlying biology of cancer, allowing physicians and patients to make individualized treatment decisions. We are translating significant amounts of genomic data that will be useful for treatment planning throughout the cancer patient’s journey, from diagnosis to treatment selection and monitoring. We offer our Oncotype tests as a clinical laboratory service, where we analyze the expression levels of genes in tumor tissue samples and provide physicians with a quantitative gene expression profile expressed as a single quantitative score, which we call a Recurrence Score for invasive breast cancer and colon cancer, a DCIS Score for ductal carcinoma in situ, or DCIS, and a Genomic Prostate Score, or GPS, for prostate cancer.

In January 2004, we launched our first Oncotype DX test, which is used to predict the likelihood of cancer recurrence and the likelihood of chemotherapy benefit in early stage invasive breast cancer patients. In January 2010, we launched our second Oncotype DX test, the first multigene expression test developed to assess risk of recurrence in stage II colon cancer patients. In late December 2011, we made Oncotype DX available for patients with DCIS, a pre-invasive form of breast cancer. In June 2012, we extended our offering of the Oncotype DX colon cancer test to patients with stage III disease treated with oxaliplatin-containing adjuvant therapy. In May 2013, we launched our Oncotype DX prostate cancer test, which is used to predict disease aggressiveness in men with low risk disease. As of April 30, 2017, the list price of our Oncotype DX breast cancer tests in the United States was $4,620, the list price of our Oncotype DX colon cancer test was $4,420, the list price of our Oncotype DX prostate cancer test was $4,520 and the list price of our Oncotype SEQ Liquid Select test was $5,800. The substantial majority of our historical revenues have been derived from the sale of Oncotype DX breast cancer tests ordered by physicians in the United States.

For the three months ended March 31, 2017, more than 31,580 Oncotype test reports were delivered for use in treatment planning, compared to more than 29,510 test reports delivered for the same period in 2016. All of our tests are conducted at our clinical reference laboratory in Redwood City, California. Our clinical reference laboratory processing capacity is currently approximately 150,000 tests annually, and has significant expansion capacity with incremental increases in laboratory personnel and equipment. The Oncotype DX breast, colon, and prostate cancer tests analyze different genes. However, all of the tests are based on a similar Oncotype DX reverse transcription polymerase chain reaction, or RT-PCR, platform. We believe that we currently have sufficient capacity to process current demand for our tests.

We have expanded our clinical laboratory facilities and processing capacity to accommodate future next generation sequencing, or NGS, testing and research and development. We expect our continued commercialization efforts of our tests will result in increased costs for laboratory testing, including staffing-related costs, incremental sales and marketing personnel to introduce our products to physicians and patients, costs for clinical utility studies and costs associated with obtaining reimbursement coverage.

We depend upon third-party payors, both public and private, to provide reimbursement for our tests. Accordingly, we have and expect to continue to focus substantial resources on obtaining and maintaining reimbursement coverage from third-party payors. Sales of our tests in the United States and other countries are dependent upon the coverage decisions and reimbursement policies established by government healthcare programs and private health insurers. Market

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acceptance of our tests has and will continue to depend upon the ability to obtain an appropriate level of coverage for, and reimbursement from, third-party payors for our tests. We have had Medicare coverage for our Oncotype DX invasive breast cancer test since 2006 and for our Oncotype DX colon cancer test since 2011. In October 2015, we obtained Medicare coverage for our Oncotype DX prostate cancer test for patients with low and very-low risk. Under the terms of the coverage determination for our prostate cancer test, reimbursement is limited to tests ordered by physicians who agree to participate in a Certification Training Registry and to provide certain information about Medicare beneficiaries who receive our test. On December 16, 2015, Palmetto GBA, a Medicare Administrative Contractor that processes Medicare claims and sets Medicare coverage and payment policies for certain tests performed by our laboratory, informed us that they believe it was appropriate to establish a unique identifier code and independent coverage for the Oncotype DX DCIS test. We have obtained a unique identifier code for the Oncotype DX DCIS test, and we submitted to Palmetto additional validation and clinical utility data generated since its previous decision in May 2013, to cover the Oncotype DX DCIS test for all qualified Medicare patients with DCIS breast cancer. On January 19, 2017, Palmetto announced that it would cover the Oncotype DX DCIS test under a new local coverage determination, or LCD, with Coverage with Data Development, or CDD, for services furnished beginning March 6, 2017.

We have continued to expand our business, both in the United States and internationally. There are significant differences between countries that need to be considered. For example, operational requirements generally vary from country to country, and different countries may have a public healthcare system, a combination of public and private healthcare system or a cash-based payment system. We have a direct commercial presence with employees in Canada, Japan and certain European counties, including our European headquarters in Geneva, Switzerland. Additionally, we have exclusive distribution agreements for the sale of our breast and colon cancer tests with distributors covering more than 90 countries outside of the United States.

As our international business expands, our financial results become more sensitive to the effect of fluctuations in foreign currency exchange rates. For example, in countries where we have a direct commercial presence, our tests are sold in local currency, which results in foreign currency exchange rate fluctuations affecting our U.S.-dollar reported revenues. In other markets where we sell our tests in U.S. dollars to distribution partners, the demand for our tests may be impacted by the change in U.S. dollar exchange rates affecting partners’ costs or local market price adjustments.

We expect that international sales of our Oncotype tests will be heavily dependent on the availability of reimbursement and sample access. In many countries, governments are primarily responsible for reimbursing diagnostic tests. Governments often have significant discretion in determining whether a test will be reimbursed at all, and if so, on what conditions, for which other competing products, and how much will be paid. In addition, certain countries, such as China, have prohibitions against exporting tissue samples which will limit our ability to offer our tests in those countries without local laboratories or a method of test delivery which does not require samples to be transported to our U.S. laboratory.

The majority of our international Oncotype DX breast and colon cancer test revenues come from direct payor reimbursement, payments from our distributors, patient self-pay, and clinical collaborations in various countries. We have obtained some coverage, which varies substantially from country to country, for our breast cancer test outside of the United States, including in Argentina, Canada, the Czech Republic, Germany, Greece, Hungary, Ireland, Israel, Saudi Arabia, Spain, Switzerland and the United Kingdom. In 2013, we announced that the National Institute for Health and Care Excellence, or NICE, in the United Kingdom issued its final guidance recommending Oncotype DX as the only multi-gene breast cancer test for use in clinical practice to guide chemotherapy treatment decisions for certain patients. We established reimbursement with NHS England following NICE’s recommendation for our breast cancer test, and in 2015 we began to receive payments from NHS England trusts with whom we have completed contractual arrangements. In 2014, the Gynecologic Oncology Working Group in Germany updated their guidelines to recommend Oncotype DX as the only breast cancer gene expression test to predict chemotherapy benefit in early-stage, hormone receptor-positive invasive breast cancer. We expect that it will take several years to establish broad coverage and reimbursement for our Oncotype DX breast, colon and prostate cancer tests with payors in countries outside of the United States and there can be no assurance that our efforts will be successful.

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Oncotype DX Breast Cancer Test

We expect to continue to focus substantial resources on pursuing global adoption of and reimbursement for our Oncotype DX breast cancer test. We believe increased demand for our Oncotype DX breast cancer test resulted from our ongoing commercial efforts, expanded utility for new breast cancer patient groups, continued publication of peer-reviewed articles on studies we sponsored, conducted or collaborated on that support the use of and reimbursement for the test, clinical presentations at major symposia, and the inclusion of our breast cancer test in clinical practice guidelines for, node negative, or N−, estrogen receptor positive, ER+, invasive disease. However, this increased demand is not necessarily indicative of future growth rates, and we cannot provide assurance that this level of increased demand can be sustained or that publication of articles, future appearances or presentations at medical conferences, increased commercial efforts or expansion of utility to new breast cancer patient groups will have a similar impact on demand for our breast cancer test in the future. Sequential quarterly demand for our breast cancer test may also be impacted by other factors, including the economic environment and seasonal variations that have historically impacted physician office visits, any shift in commercial focus, patient enrollment in Oncotype DX clinical studies and the number of clinical trials in process by cooperative groups or makers of other tests conducting experience studies.

Most national and regional third-party payors in the United States, along with the designated regional Medicare Administrator Contractor for our tests, have issued positive coverage determinations for our Oncotype DX breast cancer test for patients with N−, ER+ invasive disease through contracts, agreements or policy decisions. The local carrier with jurisdiction for claims submitted by us for Medicare patients also provides coverage for our invasive breast cancer test for ER+ patients with N+ disease (up to three positive lymph nodes) and invasive breast cancer patients where a lymph node status is unknown or not accessible due to a prior surgical procedure, or when the test is used to guide a neoadjuvant treatment decision. Additionally, some payors provide policy coverage for the use of our test in ER+ patients with N+ disease, including lymph node micro metastasis. However, we may not be able to obtain reimbursement coverage from other payors for our test for breast cancer patients with N+, ER+ disease.

We have established limited reimbursement coverage for the use of our Oncotype DX DCIS test for some private third-party payors. In many instances our test is covered under existing breast cancer coverage policies with the addition of the indicated diagnosis code for DCIS. We have also received a new LCD with CDD for our Oncotype DX DCIS test beginning March 6, 2017. We intend to continue to devote resources to expanding private reimbursement for our Oncotype DX DCIS test in this patient population. We believe it may take several years to achieve reimbursement with a majority of third-party payors for the use of our test for DCIS patients. However, we cannot predict whether, or under what circumstances, payors will reimburse for this test.

We have established coverage for our Oncotype DX breast cancer test for invasive breast cancer in a majority of state Medicaid programs for N− disease. In addition, the Veterans Administration and the Department of Defense hospitals have processes in place that provide coverage for our Oncotype DX test for invasive breast cancer.

Oncotype DX Colon Cancer Test

We expect to continue to pursue global adoption of and reimbursement for our Oncotype DX colon cancer test. We believe the key factors that will drive adoption of this test include results from studies we sponsor, conduct or collaborate on that support the use of and increased coverage and reimbursement for the test, clinical presentations at major symposia, publications, inclusion of the test in clinical guidelines and our ongoing commercial efforts.

We are working with public and private payors and health plans to secure coverage for our Oncotype DX colon cancer test based upon our published and presented results in clinical validation studies and the completed and ongoing studies designed to demonstrate the treatment decision impact of the test in clinical practice. In September 2011, the local carrier with jurisdiction for claims submitted by us for Medicare patients established coverage for our colon cancer test for patients with stage II colon cancer. Additionally, the Veterans Administration, Department of Defense hospitals and a few additional private payors provide coverage and reimbursement. We are continuing to speak with state Medicaid providers regarding coverage and reimbursement for our Oncotype DX colon cancer test. We intend to pursue reimbursement while seeking to obtain formal coverage policies with payors and expect that this test will continue to be reviewed on a case by case basis until policy decisions have been established. We may need to hire additional

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commercial, scientific, technical and other personnel to support this process. We believe it may take several years to achieve additional reimbursement with third-party payors for our colon cancer test. However, we cannot predict whether, or under what circumstances, payors will reimburse for this test.

Oncotype DX Prostate Cancer Test

We expect to continue to focus substantial resources on pursuing global adoption of and reimbursement for our Oncotype DX prostate cancer test. We believe the key factors that will drive adoption of this test include publication of the clinical validation study conducted in collaboration with the University of California, San Francisco and other studies we sponsored, conducted or collaborated on that support the use of and reimbursement for the test, clinical presentations at major symposia and our ongoing commercial efforts.

In August 2015, Palmetto issued its final LCD, approving nationwide coverage of our prostate cancer test for qualified male Medicare patients with low and very low risk disease, as defined by NCCN guidelines, throughout the United States. The LCD includes specific requirements for certification and training of physicians who order the test and requirements for collection and reporting of specific data elements related to the use of our test and patient outcomes. Effective October 2015, Palmetto initiated reimbursement of the Oncotype DX prostate cancer test. Other than Medicare coverage, we have obtained limited reimbursement coverage from third-party payors for our Oncotype DX prostate cancer test. Our prostate cancer test may be considered investigational by payors and therefore may not be covered under their reimbursement policies. Consequently, we intend to pursue case by case reimbursement and expect that this test will continue to be reviewed on this basis until policy decisions have been made by individual payors. We plan to work with public and private payors and health plans to secure coverage for our Oncotype DX prostate cancer test based upon clinical evidence demonstrating the utility of the test. We believe it may take several years to achieve reimbursement with a majority of third-party payors for our prostate cancer test. However, we cannot predict whether, or under what circumstances, payors will reimburse for this test. We may continue to hire additional commercial, scientific, technical and other personnel to support this process.

Oncotype SEQ Liquid Select

In June 2016, we announced the commercial launch of Oncotype SEQ Liquid Select, our first Oncotype SEQ product, for the management and monitoring of multiple cancer types. The initial phase of the targeted launch for Oncotype SEQ Liquid Select is focused on select clinics for the treatment of stage IV lung cancer patients. Oncotype SEQ tests, such as Oncotype SEQ Liquid Select, are non-invasive liquid biopsy mutation panels that use NGS to identify and select actionable genomic alterations to quantify the presence and burden of cancer, as well as help predict the sensitivity or resistance to specific drugs for patients with certain late-stage cancers, such as late stage lung, breast, colon, melanoma, ovarian or gastrointestinal cancer. As a targeted blood-based panel, Oncotype SEQ Liquid Select is designed to meet the needs of community oncologists by delivering actionable clinical information to more than 350,000 cancer patients who recur or present with late-stage disease each year in the United States, with potentially lower cost to both patients and payors.

Analytical validation results for Oncotype SEQ Liquid Select were presented at the European Society for Medical Oncology congress in Copenhagen, Denmark in October 2016. The validation study results demonstrated that Oncotype SEQ Liquid Select is highly sensitive, specific and reproducible. The validation study established the per-sample specificity of the test to be greater than 99 percent. The test’s sensitivity is also very high, detecting cell free DNA from tumors at the low frequencies commonly found in the plasma of patients with metastatic cancer in 95% of cases. Finally, study results demonstrated that Oncotype SEQ Liquid Select was highly reproducible in that it detected more than 95% of all observed variants in each run.

As new clinical evidence continues to be introduced, we intend to introduce new versions of the Oncotype SEQ test, which could include additional genes or updated interpretations of genes already included in such tests.

We intend to pursue reimbursement while seeking to obtain formal coverage policies with payors and expect that this test will be reviewed on a case by case basis until policy decisions have been established. We may need to hire additional commercial, scientific, technical and other personnel to support this process. We believe it may take several

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years to achieve a sufficient level of reimbursement with third party payors for our Oncotype SEQ Liquid Select test. However, we cannot predict whether, if, or under what circumstances, payors will reimburse for this test.

Product Development Opportunities

In addition to developing products to address new cancer areas, we continually look to expand the clinical utility and addressable patient populations for our existing tests. These development efforts may lead to a variety of possible new products covering various treatment decisions, including risk assessment, screening and prevention, early disease diagnosis, adjuvant and/or neoadjuvant disease treatment, metastatic disease treatment selection and patient monitoring.

Potential new products may address a variety of specific clinical needs by leveraging one or multiple technological capabilities including NGS, digital PCR and circulating tumor cell, or CTC, capture. Additionally, we believe potential new products can be implemented in the form of non-invasive tests performed on blood or urine, similar to our Oncotype SEQ Liquid Select product.

We have started the research and development phases on our first Oncotype TRACK products for non-invasive tumor monitoring, based upon positive results from our first two feasibility studies presented in December 2014. Tests such as Oncotype TRACK could leverage a variety of technologies, such as digital PCR or NGS, to cover an increasing range of indications and cancer types.

As new clinical evidence continues to be introduced, we intend to incorporate such evidence into additional iterations of these tests, which could include additional genes or updated interpretations of genes already included in such tests.

Commercial Collaborations

In June 2016, we entered into a collaboration agreement with Epic Sciences, Inc., or Epic Sciences, under which we have been granted exclusive distribution rights to commercialize Oncotype DX AR-V7 Nucleus Detect in the United States. Oncotype DX AR-V7 Nucleus Detect will be performed by Epic Sciences in its centralized laboratory in San Diego, California, which is accredited under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and certified by the College of American Pathologists, or CAP. This blood-based test detects the V7 variant of the androgen receptor, or AR, protein in the nucleus of circulating tumor cells, and provides information to help guide treatment selection in patients with metastatic castration-resistant prostate cancer, or mCRPC. In January 2017, investigators from Memorial Sloan Kettering Cancer Center and Epic Sciences published findings in European Urology, that only nuclear localization of AR-V7 protein in CTCs from mCRPC patient blood samples is predictive of therapeutic benefit. Previous work by the same team, reported in JAMA Oncology, demonstrated that nuclear localized AR-V7 protein in CTCs was predictive of a 76% reduction of risk of death for mCRPC patients who received taxane chemotherapy versus Androgen Receptor Signaling inhibitors. We believe that this collaboration is complementary to our product development efforts for our Oncotype SEQ tests and allows us to leverage our commercial channel in a way that we believe may generate growth across our business in the United States. We may also pursue additional collaboration opportunities that are intended to complement our expanding product portfolio.

Technology

Next Generation Technologies

When the presence of tumor-derived DNA in blood or urine is high and persists or increases over time, the cancer is likely growing and a new course of treatment may be appropriate. We plan on monitoring this tumor-derived DNA through a variety of technologies to expand our focus beyond early stage treatment decision support toward patients with later stage disease to help guide therapeutic choices, monitor progression and response to therapeutics, and monitor disease recurrence. Although the first product we have launched uses cell-free circulating tumor DNA in blood, we may pursue additional research and development opportunities using other analytes such as CTCs, RNA, and proteins. Additionally, while we are expanding our use of NGS for future clinical development in tandem with our existing RT-PCR approach, we might also use a number of other technologies across our various development programs and to implement our products. We have utilized NGS to develop Oncotype SEQ Liquid Select, and plan to continue to further

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utilize NGS to develop additional non-invasive liquid biopsy tests that can be performed on blood or urine. Based on the positive results from two feasibility studies presented in December 2014, we are working to develop non-invasive tests for real-time patient monitoring. While early stage cancer continues to represent a significant opportunity with near term revenue potential, we believe we have the opportunity to expand our business further along the patient’s cancer journey.

Next Generation Sequencing

We have selected NGS to be our primary technology for future biomarker discovery and utilize NGS for Oncotype SEQ Liquid Select. We will further utilize NGS for clinical development and product implementation in tandem with our existing RT-PCR based approach. NGS technologies parallelize the sequencing process, producing thousands or millions of sequences at once, and are intended to provide nucleic acid sequence information at lower cost than standard methods. We have created proprietary methods for NGS of, fixed paraffin-embedded, or FPE, tissue nucleic acids, and created bioinformatics programs, and infrastructure for data storage and analysis. We have also explored the combination and superimposition of certain whole transcriptome derived RNA information (standardized expression; univariate biomarker direction of association) on genomic information to reveal the genomic landscapes of cancers. Employing NGS methods, we have also demonstrated feasibility for fusion transcript and mutation detection in RNA from FPE tissue samples and copy number aberration and structural variation mutations in DNA from FPE samples.

Advanced Information Technology

We have developed computer programs to automate our RT-PCR and NGS assay processes. We have also developed and optimized laboratory information management systems to track our gene specific reagents, instruments, assay processes and the data generated. Similarly, we have automated data analysis, storage and process quality control. We use statistical methods to optimize and monitor assay performance and to analyze data from our development studies. We are investigating methods to further automate our workflow. In addition, we have begun investing in informatics infrastructure that incorporates a high performance computer cluster, both locally and cloud based, to analyze and store large NGS genomic data sets.

We are also working with a number of different technologies, such as digital PCR and detection and capture methods for CTCs, to expand our capabilities, and we are developing methods to enable genomic testing using a variety of biological materials such as blood and urine.  

Economic Environment

Continuing concerns over entitlement and health care reform efforts, regulatory changes and taxation issues, and geopolitical issues have contributed to uncertain expectations both for the U.S. and global economies. These factors, combined with uncertainties in business and consumer confidence and continued concerns regarding the stability of some European Union member countries, have contributed to the expectations of slower domestic and global economic growth in the near term. We periodically evaluate the impact of the economic environment on our cash management, cash collection activities and volume of tests delivered.

We periodically monitor the financial position of our significant third-party payors, which include Medicare and managed care companies. As of the date of this report, we do not expect the current economic environment to have a material negative impact on our ability to collect payments from third-party payors in the foreseeable future. We believe the economic environment and changes in the healthcare system continued to impact product payment cycles, growth in tests delivered and product revenue generated during the three months ended March 31, 2017. We intend to continue to assess the impact of the economic environment on our business activities. If the economic environment does not improve or deteriorates, our business including our patient population, government and third-party payors and our distributors and suppliers could be negatively affected, resulting in a negative impact on our product revenues.

U.S. Healthcare Reimbursement and Regulatory Environment

The healthcare industry has undergone significant change driven by various efforts to reduce costs. The effect of the implementation of the Affordable Care Act, or ACA, or any future changes to the ACA on our business is uncertain.

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Among other things, the law requires medical device manufacturers to pay a 2.3% excise tax on U.S. sales of certain medical devices that are listed with the FDA starting in January 2013; this tax has been suspended for 2016 and 2017, but is scheduled for re-imposition in 2018. Although various proposals have been put forth, including by the FDA that, if finalized, would result in FDA regulation of certain clinical laboratory tests that are developed and validated by a laboratory for its own use, referred to as LDTs, as medical devices, none of our LDTs, such as our Oncotype DX breast, colon and prostate cancer tests, are currently listed with the FDA. We cannot assure you that the tax will not apply to services such as ours in the future.

Healthcare reform proposals and medical cost containment measures are being adopted in the U.S. and in many foreign countries. These reforms and measures, including those envisioned by the adoption in 2010 of the ACA and subsequent proposals to repeal or replace the ACA, could among other things limit the use of our tests and reduce reimbursement. We also expect that pricing of medical products and services will remain under pressure as alternative payment models such as bundling, value-based purchasing and accountable care organizations develop in the United States.

In addition, the Protecting Access to Medicare Act of 2014, or PAMA includes a substantial new payment system for certain clinical laboratory tests that is currently scheduled to be effective starting in 2018. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the Clinical Laboratory Fee Schedule, or CLFS, or the Physician Fee Schedule will be required to report every three years (or annually for “advanced diagnostic laboratory tests”), private payor payment rates and volumes for their tests. The Centers for Medicare and Medicaid Services, or CMS, will use the rates and volumes reported by laboratories to develop Medicare payment rates for the tests equal to the volume-weighted median of the private payor payment rates for the tests.

There have also been recent and substantial changes to the payment structure for physicians, including those passed as part of the Medicare Access and CHIP Reauthorization Act of 2015, or MACRA, which was signed into law on April 16, 2015. MACRA created the Merit-Based Incentive Payment System which, beginning in 2019, more closely aligns physician payments with composite performance the Physician Quality Reporting System, the Value-based modifier program and the Electronic Health Record Meaningful Use program, and incentivizes physicians to enroll in alternative payment methods. At this time, we do not know whether these changes to the physician payment systems will have any impact on orders or payments for our tests.

We received a specific Current Procedural Terminology, or CPT, code for our Oncotype DX invasive breast cancer test effective January 1, 2015. Medicare has established a national limitation amount for this code under the gapfill process that maintains the contractor amount currently in effect through 2017. New rates calculated using the methodology under PAMA are currently expected to be adopted in 2018.

We received a specific CPT code for our Oncotype DX colon cancer test, effective January 1, 2016. For 2016, Medicare claims were paid at the rate established by the local MACs under the gapfill process. Medicare has established a national limitation amount for this code that maintains the contractor amount through 2017. New rates required under PAMA will be adopted in 2018.

Changes in Medicare Administrative Contractor (MAC) services

On a five year rotational basis, Medicare requests bids for its regional MAC services. In September 2013, the claims processing function for our jurisdiction transitioned from Palmetto GBA, to our current MAC, Noridian. Palmetto GBA under their MolDx Program is continuing to establish coverage, coding and reimbursement policies for molecular diagnostic tests performed in our jurisdiction, including our tests, which is not subject to the same five-year rotation as for regional MAC services. The elimination of the MolDx Program or a change in the administrator of that program could impact the current coverage or payment rates for our existing tests and our ability to obtain Medicare coverage for products for which we do not yet have coverage or any products we may launch in the future, or delay payments for our tests.

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Critical Accounting Policies and Significant Judgments and Estimates

 

The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts in the financial statements and related disclosures. On an ongoing basis, management evaluates its significant accounting policies and estimates. We base our estimates on historical experience and on various market-specific and other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates. Estimates are assessed each period and updated to reflect current information. A summary of our critical accounting policies is presented in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes to our critical accounting policies during the quarter ended March 31, 2017, other than the adoption of Accounting Standards Update ("ASU") 2016-09 described below.

Results of Operations

 

Three Months Ended March 31, 2017 and 2016

 

We recognized a net loss of $806,000 for the three months ended March 31, 2017 compared to a net loss of $6.4 million for the three months ended March 31, 2016. On a basic and diluted per share basis, net loss per share was $0.02 for the three months ended March 31, 2017 compared to net loss per share of $0.19 for the three months ended March 31, 2016. We may incur net losses in future periods due to future spending and fluctuations in our business, and we may not achieve or maintain sustained profitability in the future.

 

Revenues

 

We derive our revenues primarily from product sales and, in some periods, from contract research arrangements. We operate in one industry segment. As of March 31, 2017, the substantial majority of our product revenues have been derived from the sale of our Oncotype DX breast cancer test. Payors are billed upon generation and delivery of test results to the ordering physician. Product revenues are recorded on a cash basis unless a contract or arrangement to pay is in place with the payor at the time of billing and collectability is reasonably assured.

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

 

March 31,

 

 

 

2017

 

2016

 

Product revenues

 

$

83,979

    

$

80,894

 

Period over period dollar increase in product revenues

 

$

3,085

 

 

 

 

Period over period percentage increase in product revenues

 

 

 4

%  

 

 

 

 

The period over period increase in product revenues resulted, in part, from increased adoption. Test volume increased by 7% for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. Of the growth in test volume, approximately 4% was from breast cancer tests delivered worldwide.

International product revenues were $13.4 million, or 16% of product revenues for the three months ended March 31, 2017 compared to $10.4 million, or 13% of product revenues, for the three months ended March 31, 2016.

 

Approximately $60.7 million, or 72% of product revenues for the three months ended March 31, 2017 were recorded on an accrual basis and recognized at the time the test results were delivered, compared to $59.3 million, or 73% of product revenues for the three months ended March 31, 2016. For all periods, the balance of product revenues was recognized upon cash collection as payments were received. The timing of recognition of revenues related to third-party payments may cause fluctuations in product revenues from period to period.

 

Product revenues related to Medicare patients for the three months ended March 31, 2017 were $19.9 million, or 24% product revenues compared to $18.4 million, or 23% of product revenues for the three months ended March 31, 2016. There were no other third-party payors comprising product revenues of 10% or more for those periods.

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Cost of Product Revenues

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Tissue sample processing costs

 

$

13,386

 

$

13,436

 

Stock-based compensation

 

 

191

 

 

176

 

Total tissue sample processing costs

 

 

13,577

 

 

13,612

 

License fees

 

 

95

 

 

2,541

 

Total cost of product revenues

 

$

13,672

 

$

16,153

 

Period over period dollar decrease in tissue sample processing costs

 

$

(50)

 

 

 

 

Period over period percentage decrease in tissue sample processing costs

 

 

 —

%  

 

 

 

 

Cost of product revenues includes the cost of materials, direct labor, equipment and infrastructure expenses associated with processing tissue samples (including sample accessioning, histopathology, anatomical pathology, paraffin extraction, RT-PCR, quality control analyses and shipping charges to transport tissue samples) and license fees. Infrastructure expenses include allocated facility occupancy and information technology costs. Costs associated with performing our tests are recorded as tests are processed. Costs recorded for tissue sample processing represent the cost of all the tests processed during the period regardless of whether revenue was recognized with respect to that test. Historically, royalties for licensed technology calculated as a percentage of product revenues and fixed annual payments relating to the launch and commercialization of Oncotype tests were recorded as license fees in cost of product revenues at the time product revenues are recognized or in accordance with other contractual obligations. For the three months ended March 31, 2017, the decrease in license fees is primarily due to the satisfaction of certain royalty payment obligations for the license of PCR patents under a license agreement with Roche Molecular Systems, Inc. In previous periods, license fees were generally calculated as a percentage of product revenues. As a result of the termination of the Roche license agreement, we expect license fees expense to be consistent with the levels recognized during the three months ended March 31, 2017, which are significantly less than amounts recognized in the first half of 2016.

 

Tissue sample processing costs decreased $50,000 for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The decrease was driven primarily by the increase of cost allocation to other functional areas offset by increase in cost of materials driven primarily by the increase in test volume, and higher materials costs and an increase in personnel-related expenses due to increased headcount. We expect the cost of product revenues to increase in future periods to the extent we process more tests.

 

Research and Development Expenses

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Personnel-related expenses

    

$

9,175

    

$

9,484

 

Stock-based compensation

 

 

1,389

 

 

1,237

 

Collaboration expenses

 

 

821

 

 

704

 

Reagents and laboratory supplies

 

 

777

 

 

639

 

Allocated information technology, facilities and other costs

 

 

1,476

 

 

1,936

 

Other costs

 

 

1,236

 

 

1,610

 

Total research and development expenses

 

$

14,874

 

$

15,610

 

Period over period dollar decrease

 

$

(736)

 

 

 

 

Period over period percentage decrease

 

 

(5)

%  

 

 

 

 

Research and development expenses represent costs incurred to develop our technology, our proprietary liquid platform and continuous process improvement, and carry out clinical studies, primarily related to our ongoing work in breast, colon and prostate cancer. Research and development expenses include personnel related expenses, reagents and

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supplies used in research and development laboratory work, collaboration expenses, infrastructure expenses, including allocated overhead and facility occupancy costs, contract services and other outside costs.

 

The $736,000, or 5%, decrease in research and development expenses for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a $460,000 decrease in allocated information technology, facilities and other costs, a $374,000 decrease in other costs and a $309,000 decrease in personnel-related expenses partially offset by a $152,000 increase in stock-based compensation and a $138,000 increase in reagents and laboratory supplies.

 

We expect our research and development expenses to increase in future periods due to increased investment in our new product pipeline for breast, colon, prostate and other cancers, along with increased investment in our proprietary liquid platforms.

 

Selling and Marketing Expenses

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2017

 

2016

 

 

 

 

(In thousands)

 

 

Personnel-related expenses

    

$

21,381

    

$

21,374

 

 

Stock-based compensation

 

 

1,511

 

 

1,438

 

 

Promotional and marketing materials

 

 

4,130

 

 

3,665

 

 

Travel, meetings and seminars

 

 

4,547

 

 

4,697

 

 

Collaboration expenses

 

 

114

 

 

233

 

 

Allocated information technology, facilities and other costs

 

 

8,750

 

 

7,084

 

 

Other costs

 

 

1,074

 

 

1,009

 

 

Total selling and marketing expenses

 

$

41,507

 

$

39,500

 

 

Period over period dollar increase

 

$

2,007

 

 

 

 

 

Period over period percentage increase

 

 

 5

%  

 

 

 

 

 

Our selling and marketing expenses consist primarily of personnel related expenses, education and promotional expenses, market analysis and development expenses and infrastructure expenses, including allocated facility occupancy and information technology costs. These expenses include the costs of educating physicians, laboratory personnel and other healthcare professionals regarding our genomic technologies, how our tests are developed and validated and the value of the quantitative information that our tests provide. Selling and marketing expenses also include the costs of sponsoring continuing medical education, medical meeting participation and dissemination of scientific and economic publications related to our tests. Our sales force compensation includes annual salaries and eligibility for quarterly commissions based on the achievement of predetermined sales goals and other management objectives.

The $2.0 million, or 5%, increase in selling and marketing expenses for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a $1.7 million increase in allocated information technology, facilities and other costs primarily associated with the implementation of new systems and a $465,000 increase in a promotional and marketing materials partially offset by a $150,000 decrease in travel, meeting and seminars.

 

We expect selling and marketing expenses will continue to increase in future periods due to our efforts to establish adoption of and reimbursement for our new products, continued investment in our global commercial infrastructure and increases in our sales force and incurring other expenses to support the growth of our business.

 

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General and Administrative Expenses

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Personnel-related expenses

    

$

13,178

    

$

14,199

 

Stock-based compensation

 

 

2,014

 

 

1,691

 

Occupancy and equipment expenses

 

 

7,751

 

 

7,054

 

Billing and collection fees

 

 

2,920

 

 

3,007

 

Bad debt expense

 

 

412

 

 

2,279

 

Professional fees and other expenses

 

 

2,627

 

 

2,482

 

Information technology, facilities and other cost allocations

 

 

(12,151)

 

 

(12,274)

 

Total general and administrative expenses

 

$

16,751

 

$

18,438

 

Period over period dollar decrease

 

$

(1,687)

 

 

 

 

Period over period percentage decrease

 

 

(9)

%  

 

 

 

 

Our general and administrative expenses consist primarily of personnel-related expenses, occupancy and equipment expenses, including rent and depreciation expenses, billing and collection fees, bad debt expense, professional fees and other expenses, including intellectual property defense and prosecution costs, and other administrative costs, partially offset by cost allocations to our commercial laboratory operations, research and development, and sales and marketing functions, including allocated information technology and facility occupancy costs.

 

The $1.7 million, or 9%, decrease in general and administrative expenses for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a $1.9 million decrease in bad debt expense driven by improved cash collections, the reversal of certain bad debt reserves, and a $1.0 million decrease in personnel-related expenses partially offset by a $697,000 increase in occupancy and equipment expenses driven by increased software license expenses and facility expansion and a $323,000 increase in stock-based compensation. The $1.0 million decrease in personnel-related expenses was primarily due to a $1.5 million decrease in contract labor and consulting expenses partially offset by a $461,000 increase in salaries, benefits and bonus expenses due to increased headcount and higher benefits costs.

 

We expect general and administrative expenses to increase in future periods as we hire additional staff and incur other expenses to support the growth of our business, and to the extent we spend more on billing and collections fees and bad debt expense.

 

Interest Income

 

Interest income was $158,000 for the three months ended March 31, 2017 compared to $78,000 for the three months ended March 31, 2016. We expect our interest income will remain nominal if the current low interest rate environment continues.

 

Gain on sale of equity securities

 

For the three months ended March 31, 2017 and 2016, we realized gain on sale of equity securities of $2.8 million and $1.3 million, respectively, in connection with the sale of our common stock of Invitae Corporation, or Invitae. As of March 31, 2017, we had sold all of our remaining shares of common stock of Invitae.

 

Other Income (Expense), Net

 

Other income, net was $95,000 for the three months ended March 31, 2017 compared to other income, net of $87,000 for the three months ended March 31, 2016. Other income, net for the three months ended March 31, 2017 and 2016 was primarily related to $77,000 and $75,000 of net foreign currency gains, respectively, resulting from valuation adjustments to our international accounts receivable balance. We expect other income (expense), net to continue to fluctuate based on fluctuations in exchange rates that impact our foreign currency transaction gains and losses.

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