CASTLE BIOSCIENCES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes and other financial information included in this Quarterly Report on Form 10-Q and our audited financial statements and notes thereto as of and for the years ended December 31, 2022 and 2021 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, including the section entitled “Critical Accounting Estimates,” included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2023. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “Castle,” “we,” “us” and “our” refer to Castle Biosciences, Inc. Forward-Looking Statements The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipate,” “believe,” “estimate,” “expect,” “may,” “plan,” “potential,” “will,” “would” or the negative or plural of these terms or other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions or expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements, except as may be required by law. Overview Castle Biosciences is applying innovative diagnostics to inform disease management and improve patient outcomes. For the diseases that our portfolio of tests cover, we believe the traditional approach to developing a treatment plan for cancers and other diseases using clinical and pathology factors alone is inadequate and can be improved by incorporating the personalized information our tests provide. Our Test Portfolio We currently offer five proprietary multi-analyte assays with algorithmic analysis (“MAAA”) tests for use in the dermatologic, ocular and gastroenterology fields. We also offer a proprietary pharmacogenomics (“PGx”) test to guide optimal drug treatment for patients suffering from depression, anxiety and other mental health conditions following our acquisition of AltheaDx, Inc. (“AltheaDx”) in April 2022, as discussed below. Currently, our revenue is primarily generated by our DecisionDx-Melanoma risk stratification gene expression profile (“GEP”) test for cutaneous melanoma, which is supplemented by revenue generated from our DecisionDx-SCC risk stratification test for cutaneous squamous cell carcinoma (“SCC”), our TissueCypher risk stratification test for Barrett’s esophagus (“BE”) and our DecisionDx-UM risk stratification test for uveal melanoma (“UM”). All five of our MAAA tests have been granted Advanced Diagnostic Laboratory (“ADLT”) test status by the Centers for Medicare & Medicaid Services (“CMS”) which means each test has demonstrated that (i) when combined with an empirically derived algorithm, it yields a result that predicts the probability a specific individual patient will develop a certain condition or conditions, or will respond to a particular therapy or therapies; and (ii) it provides new clinical diagnostic information that cannot be obtained from any other test or combination of tests. We believe this designation not only demonstrates our focus on developing and validating innovative tests but also enables our Medicare reimbursement rate to be set, over the long term, by the median private payor rate, which we believe provides a fair exchange of value. Further information about Medicare coverage and ADLT status with respect to each of our tests is set forth below. 22 Table of Contents Test Overview Our Dermatologic Tests Our lead product is DecisionDx-Melanoma, a proprietary risk stratification GEP test that predicts the risk of metastasis or recurrence for patients diagnosed with invasive cutaneous melanoma. In a typical year, we estimate approximately 130,000 patients are diagnosed with invasive cutaneous melanoma in the United States, representing an estimated U.S. total addressable market (“TAM”) of approximately $540 million. We launched DecisionDx-Melanoma in May 2013. DecisionDx‑SCC is our proprietary GEP test for use in patients with SCC, with one or more risk factors (also referred to as “high-risk” SCC). We estimate 200,000 SCC patients are annually diagnosed and classified at high risk in the United States, are classified as high risk, representing an estimated U.S. TAM of approximately $820 million. We launched DecisionDx-SCC in August 2020. Initially, we offered both our MyPath Melanoma test and our DiffDx-Melanoma test under an offering that we referred to as our Diagnostic GEP offering for use in patients with a melanocytic lesion and uncertainty related to the malignancy of the lesion representing an estimated U.S. TAM of approximately $600 million. However, following an internal assessment of the clinical value of offering both tests, we made the decision to suspend the clinical offering of DiffDx-Melanoma in February 2023 and now the focus of this offering is MyPath Melanoma. Our Gastroenterology Test The TissueCypher Barrett’s Esophagus Test (sometimes referred to as “TissueCypher”) is the world’s first precision medicine test designed to predict future development of high-grade dysplasia and/or esophageal cancer in patients with non-dysplastic, indefinite dysplasia or low-grade dysplasia Barrett’s Esophagus. We estimate a U.S. TAM of approximately $1 billion. We began offering the TissueCypher Barrett’s Esophagus Test following our acquisition of Cernostics, Inc. (“Cernostics”) in December 2021. In the second quarter of 2023, we opened a new laboratory in Pittsburgh, Pennsylvania where we process our TissueCypher Barrett's Esophagus Test. We have seen such a strong adoption of the test from the gastrointestinal community that our orders have outpaced our forecasts as well as our process improvements and automation efforts. In July 2023, in response to significant demand, we elected to temporarily pause accepting additional orders for the TissueCypher Barrett’s Esophagus Test in order to bring our process improvements and additional instrumentation and personnel on line. We are currently working through these efforts and believe that we will be able to begin accepting new orders prior to the end of third quarter of 2023. Our Uveal Melanoma Test DecisionDx-UM is a proprietary, risk stratification GEP test that predicts the risk of metastasis for patients with UM. We believe DecisionDx-UM is the standard of care in the management of newly diagnosed UM in the majority of ocular oncology practices in the United States. We estimate a U.S. TAM of approximately $10 million. Our Mental Health Test IDgenetix is a PGx test for depression, anxiety and other mental health conditions. We estimate a U.S. TAM of approximately $5 billion associated with this test. We began offering the IDgenetix test following our acquisition of AltheaDx in April 2022. Commercial Expansion Efforts In late April 2022, we acquired AltheaDx and a commercial team covering approximately 20 outside sales territories. In September 2022, we added additional outside territories for our TissueCypher Barrett’s Esophagus Test and established a new commercial sales team dedicated to our Diagnostic GEP offering, with the current dermatologic commercial team shifting to focus primarily on DecisionDx-Melanoma and DecisionDx-SCC. The new sales teams were fully integrated into our commercial operations by the end of the second quarter of 2023. We will continue to assess market response in determining further commercial expansions. Reimbursement The primary source of revenue for our products is reimbursement from third-party payors, which includes government payors, such as Medicare, and commercial payors, such as insurance companies. Achieving broad coverage and reimbursement of our current products by third-party payors and continued Medicare coverage are key components of our financial success. De novo coverage by government and third-party payors for our pipeline tests will be important over time. 23 Table of Contents We bill third-party payors and patients for the tests we perform. The majority of our revenue collections is paid by third-party insurers, including Medicare. We have received Medicare coverage for our DecisionDx-Melanoma, DecisionDx-SCC, MyPath Melanoma, DecisionDx-UM, TissueCypher and IDgenetix tests which meet certain criteria for Medicare and Medicare Advantage beneficiaries, representing approximately 60 million covered lives. A ‘‘covered life’’ means a subscriber, or a dependent of a subscriber, who is insured under an insurance carrier’s policy. The Medicare rates discussed below are prior to giving effect to applicable sequestration in effect from time to time as described in further detail under “Government Regulation and Product Approval—Healthcare Reform” included in Item 1, Business, of our Annual Report on Form 10-K for the year ended December 31, 2022. DecisionDx-Melanoma LCD Palmetto GBA MolDX (“Palmetto”), the Medicare Administrative Contractor (“MAC”) responsible for administering MolDX, the program that assesses molecular diagnostic technologies, issued a final expanded local coverage determination (“LCD”) for DecisionDx-Melanoma, effective November 22, 2020. With this expanded LCD and the accompanying billing and coding articles, we estimate that a significant majority of the DecisionDx-Melanoma tests performed for Medicare patients will meet the coverage criteria. Noridian Healthcare Solutions, LLC (“Noridian”), the MAC responsible for administering claims for laboratory services performed in our Arizona laboratory, has adopted the same coverage policy as Palmetto and also issued an expanded final LCD for DecisionDx-Melanoma, effective December 6, 2020. More recently, Palmetto converted the DecisionDx-Melanoma test-specific LCD to a “foundational” LCD. This LCD was issued as final May 19, 2022 with Noridian issuing the same on June 16, 2022. The final LCDs did not result in any changes in coverage. ADLT On May 17, 2019, CMS determined that DecisionDx-Melanoma meets the criteria for ADLT status. Since 2022, the rate for DecisionDx-Melanoma is set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2023 was set using median private payor rate data from January 1, 2021 to June 30, 2021. The rate for 2022 was $7,193 per test and continues to be $7,193 per test for 2023. DecisionDx-UM LCD Palmetto issued a final LCD for DecisionDx-UM, which became effective in July 2017. Noridian, the MAC responsible for administering claims for laboratory services performed in our Arizona laboratory, has adopted the same coverage policy as Palmetto. ADLT On May 17, 2019, CMS determined that DecisionDx-UM meets the criteria for “existing advanced diagnostic laboratory test” status, also referred to as “existing ADLT” status. Our rate is set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2023 was set using median private payor rate data from January 1, 2021 to June 30, 2021. The rate for 2022 was $7,776 per test and the rate for 2023 remains at $7,776 per test. Diagnostic GEP Offering MyPath Melanoma MyPath Melanoma is currently covered under a MolDX LCD policy through Noridian that first became effective in June 2019. ADLT MyPath Melanoma was approved as a new ADLT in September 2019. The rate for 2022 was $1,950 per test. Our 2023 rate is set at $1,755 per test, based on data submitted by the predecessor owner of the Myriad MyPath Laboratory relating to the first half of 2021. Rates for our MyPath Melanoma test continues to be set annually based upon the median private payor rate for the first half of the second preceding calendar year. 24 Table of Contents DiffDx-Melanoma In early 2021, we submitted our technical assessment dossier for DiffDx-Melanoma. The dossier was accepted as complete in the first quarter of 2021. In June 2022, Palmetto and Noridian each posted a proposed LCD that would convert the MyPath Melanoma test-specific LCD to a “foundational” LCD and provide coverage for both MyPath Melanoma and DiffDx-Melanoma. On June 22, 2023, Palmetto and Noridian issued final foundational LCDs that will provide coverage for both MyPath Melanoma and DiffDx-Melanoma effective August 6, 2023. In the second quarter of 2022, we obtained a Proprietary Laboratory Analyses (“PLA”) code for DiffDx-Melanoma. DiffDx-Melanoma is going through CMS’s gapfill pricing process in 2023, which we expect to conclude in late 2023 and to be effective January 1, 2024. The gapfill process consists of several steps throughout the calendar year. First, individual MACs develop gapfill rates and report them to CMS. Using this information, CMS then posts preliminary rates and commences a public comment period. After evaluating public comments, CMS posts updated rates and begins accepting requests to reconsider these rates, known as reconsideration requests. After CMS processes any reconsideration requests, the gapfill rates are considered final. In April 2023, CMS posted a preliminary determination of a gapfill rate for DiffDx-Melanoma of $1,950 per test, which is subject to a public comment period and any reconsideration requests. We cannot predict at this time what the final gapfill rate will be. DecisionDx‑SCC In the first quarter of 2022, we requested that Novitas Solutions, Inc. (“Novitas”), the MAC that manages the Medicare jurisdiction covering our Pittsburgh, Pennsylvania laboratory, conduct a medical review of our DecisionDx-SCC test. That review was completed towards the end of that quarter. In the second quarter of 2022, following the completion of a requested medical review and pricing of our DecisionDx-SCC test by Novitas, we obtained a PLA code and began receiving reimbursement from Novitas for DecisionDx-SCC at a rate of $3,873 per test. LCD On June 2, 2023, Novitas finalized the oncology biomarker LCD pursuant to which the DecisionDx-SCC test would no longer be covered by Medicare effective July 17, 2023. However, on July 6, 2023, Novitas suspended the final version of the LCD and announced its intent to post a new proposed LCD for comment and presentation at an open meeting. On July 27, 2023, Novitas posted a nearly identical proposed oncology biomarker LCD that continues to intend to rely upon evidentiary reviews sourced from three databases: ClinGen, OncoKB and NCCN. The proposed LCD also recommends non-coverage for our DecisionDx-SCC test. The comment period for the proposed LCD ends on September 9, 2023. We cannot predict whether this LCD will be finalized as proposed or what the timing of any final LCD might be. In the second quarter of 2020, we submitted our technical assessment dossier for DecisionDx-SCC to Palmetto and Noridian. The dossier was accepted as complete in the third quarter of 2020. On June 8, 2023, both Palmetto and Noridian posted their draft LCD recommending no coverage for DecisionDx-SCC. The comment period for the draft LCDs ended on July 22, 2023. ADLT On June 30, 2023, CMS determined DecisionDx-SCC meets the criteria for “new ADLT” status. Effective July 1, 2023 and through March 31, 2024, CMS set the initial period rate equal to the list price of $8,500. Effective April 1, 2024 and through December 31, 2025, the published Clinical Laboratory Fee Schedule (“CLFS”) rate for DecisionDx-SCC will be based on the median private payor rates received between July 1, 2023 and November 30, 2023. Thereafter, the rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. ADLT status determines the process by which the rate is set and is not an indication of Medicare coverage. TissueCypher TissueCypher is processed in our Pittsburgh, Pennsylvania laboratory and falls under the Medicare jurisdiction managed by Novitas which previously reviewed TissueCypher. We receive payments for claims according to the published CLFS rate. For 2022, the published CLFS payment rate was $2,513 for the test. On March 24, 2022, CMS determined that TissueCypher meets the criteria for “new ADLT” status. From April 1, 2022 through December 31, 2022, CMS has set the initial period rate equal to the original list price of $2,350. Effective January 1, 2023, the published CLFS rate for TissueCypher is $4,950, which will remain effective through December 31, 2024. This rate is based on the median private payor rates received between April 1, 2022 and 25 Table of Contents August 31, 2022. Thereafter, the rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. IDgenetix IDgenetix is currently covered under an LCD policy through MolDX and an accompanying billing and coding article through Noridian. The Medicare coverage includes depression and the following seven additional mental health conditions beyond major depressive disorder: schizophrenia, bipolar disorder, anxiety disorders, social phobia, obsessive-compulsive personality disorder, post-traumatic stress disorder and attention deficit hyperactivity disorder. IDgenetix has historically been billed to Medicare using an unspecified Current Procedural Terminology (“CPT”) code along with the IDgenetix test-specific MolDX Z-code (the “IDgenetix Z-Code”). In February 2023, MolDX notified us that as part of its annual CPT code updates. IDgenetix should shift billing to a different generic gene sequencing CPT code (the “New CPT Code”) and continue using the IDgenetix Z-Code beginning in March 2023. The New CPT Code is currently contractor priced at $917 while it undergoes CMS’s gapfill pricing process in 2023. Accordingly, as a result of this change, the Medicare reimbursement rate for the IDgenetix multi-gene panel decreased from approximately $1,500 per test to $917 per test. The New CPT Code does not describe all of the components of the IDgenetix test. We subsequently obtained a test-specific PLA CPT code. The new PLA code becomes effective October 1, 2023 and is currently undergoing the 2024 CLFS pricing process. Delivered Test Reports The number of test reports we generate is a key indicator that we use to assess our business. A test report is generated when we receive a sample in our laboratory, and then the relevant test information is entered into our Laboratory Information Management System, the laboratory portion of the test is performed, including proprietary algorithmic analysis of the combined biomarkers, and a report is then generated which is sent to the clinician who ordered the test. The number of test reports delivered by us during the six months ended June 30, 2023 and 2022 and for the year ended December 31, 2022 are presented in the table below: Proprietary Dermatologic GEP Tests DecisionDx- Melanoma DecisionDx-SCC Diagnostic GEP offering (1) Dermatologic Total DecisionDx-UM TissueCypher Barrett’s Esophagus Test IDgenetix (2) Grand Total Q1 2023 7,583 2,411 980 10,974 409 1,383 2,150 14,916 Q2 2023 8,597 2,681 953 12,231 461 1,447 2,681 16,820 For the six months ended June 30, 2023 16,180 5,092 1,933 23,205 870 2,830 4,831 31,736 Q1 2022 6,023 1,142 950 8,115 456 56 — 8,627 Q2 2022 7,125 1,344 955 9,424 431 352 827 11,034 For the six months ended June 30, 2022 13,148 2,486 1,905 17,539 887 408 827 19,661 Q3 2022 7,354 1,636 834 9,824 392 690 1,208 12,114 Q4 2022 7,301 1,845 822 9,968 432 1,030 1,214 12,644 For year ended December 31, 2022 27,803 5,967 3,561 37,331 1,711 2,128 3,249 44,419 (1) Includes MyPath Melanoma and DiffDx-Melanoma. We offered both MyPath Melanoma and DiffDx-Melanoma under our Diagnostic GEP offering until February 2023 when we suspended the offering of DiffDx-Melanoma, as discussed above. (2) We began offering the IDgenetix test on April 26, 2022, following our acquisition of AltheaDx. Includes both single-gene and multi-gene tests. For the three and six months ended June 30, 2023, our test report volume increased by 52.4% and 61.4% respectively, compared to the same periods of 2022. Our dermatologic test report volume increased by 29.8% and 32.3% for the three and six months ended June 30, 2023, respectively, compared to the prior periods in 2022, 26 Table of Contents largely driven by continued growth from our DecisionDx-Melanoma and DecisionDx-SCC tests. Increases from our other tests (non-dermatologic), primarily TissueCypher and IDgenetix, also contributed to the overall volume increase. For a discussion of how we recognize revenue derived from our tests, refer to “Net Revenues” under “Components of Results of Operations” below. We continue to see new clinicians order our dermatologic tests for the first time. For the three months ended June 30, 2023, we saw approximately 567 new ordering clinicians for our dermatologic tests compared to 608 during the same period of 2022. For the six months ended June 30, 2023 and 2022, we saw approximately 1,106 and 1,200, respectively, new ordering clinicians for our dermatologic tests. Total ordering clinicians for our dermatologic tests were approximately 2,067 and 2,032 for the three months ended June 30, 2023 and 2022, respectively, and 6,592 and 5,661 for the six months ended June 30, 2023 and 2022, respectively. For additional information on the metrics we disclose, refer to “Information About Certain Metrics” below. In developing our DecisionDx-SCC test, we believed that in addition to addressing significant unmet clinical needs, we would see opportunities for leverage, as many of the clinicians currently ordering DecisionDx-Melanoma would likely be the same clinicians who would find value in our DecisionDx-SCC test. For example, we found that during the six months ended June 30, 2023, approximately 69% of all clinicians ordering DecisionDx-SCC had also ordered our DecisionDx-Melanoma test during that same period. Information About Certain Metrics The following provides additional information about certain metrics we have disclosed in this Management’s Discussion and Analysis of Financial Condition and Results of Operation. Test Reports Delivered Test reports delivered represents the number of completed test reports delivered by us during the reporting period indicated. The period in which a test report is delivered does not necessarily correspond with the period the related revenue, if any, is recognized, due to the timing and amount of adjustments for variable consideration under Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”). We use this metric to evaluate the growth in adoption of our tests and to measure against our internal performance objectives. We believe this metric is useful to investors in evaluating the volume of our business activity from period-to-period that may not be discernible from our reported revenues under ASC 606. New Ordering Clinicians New ordering clinicians for our dermatologic tests represents the number of clinicians who ordered a dermatologic test from us for the first time during the reporting period specified. Our dermatologic tests currently consist of DecisionDx-Melanoma, DecisionDx-SCC and MyPath Melanoma. We believe this metric is useful in evaluating the effectiveness of our sales and marketing efforts in establishing new relationships with clinicians and increasing the adoption of our suite of dermatologic tests. We also believe this metric provides useful information to investors in assessing our ability to expand the use of our dermatologic tests. Since this metric is based upon the reporting period in which an order is placed, it does not necessarily correspond to the reporting period in which a test report was delivered or revenue was recognized. Other Events Impact of Macroeconomic Conditions Macroeconomic conditions, including uncertainties associated with COVID-19, the ongoing conflict between Ukraine and Russia, economic slowdowns, labor shortages, recessions or market corrections, supply chain disruptions, inflation and monetary policy shifts, liquidity concerns at, and failures of, banks and other financial institutions or other disruptions in the banking system or financing markets, rising interest rates and financial and credit market fluctuations, volatility in the capital markets or other evolving macroeconomic developments, continue to have direct and indirect impacts on our business and could in the future materially impact our results of operations and financial condition. We continue to actively monitor the impact of these macroeconomic factors on our results of operations, financial condition and cash flows. The extent of the impact of these factors on our operational performance and financial condition, including our ability to execute our business strategies and initiatives in the expected timeframe, will depend on future developments, which are uncertain and cannot be predicted; however, any continued or renewed disruption resulting from these factors could negatively impact our business. 27 Table of Contents Our Financial Results Our net (loss) income may fluctuate significantly from period to period, depending on the timing of our planned development activities, the growth of our sales and marketing activities and the timing of revenue recognition under ASC 606. We expect our expenses will increase substantially over time as we: • execute clinical studies to generate evidence supporting our current and future product candidates; • execute our commercialization strategy for our current and future commercial products; • continue our ongoing and planned development of new products in our pipeline; • seek to discover and develop additional product candidates; • hire additional scientific and research and development staff; and • add additional operational, financial and management information systems and personnel. Factors Affecting Our Performance We believe there are several important factors that have impacted, and that we expect will continue to impact, our operating performance and results of operations, including: • Report volume. We believe that the number of reports we deliver to clinicians is an important indicator of the growth of adoption among the healthcare provider community. Our revenue and costs are affected by the volume of testing and mix of customers. Our performance depends on our ability to retain and broaden adoption with existing prescribing clinicians, as well as attract new clinicians. Our report volume could be negatively impacted by developments related to evolving macroeconomic developments, as discussed above. • Reimbursement. We believe that expanding reimbursement is an important indicator of the value of our products. Payors require extensive evidence of clinical utility, clinical validity, patient outcomes and health economic benefits in order to provide reimbursement for diagnostic products. Our revenue depends on our ability to demonstrate the value of our products to these payors. • Gross margin. We believe that our gross margin is an important indicator of the operating performance of our business. Higher gross margins reflect the average selling price of our tests, as well as the operating efficiency of our laboratory operations. • Expansion of our sales force and marketing programs. We believe the expansion of our direct sales force and marketing organization to educate clinicians and pathologists on the value of our molecular testing products will significantly impact our performance. • Integrating acquisitions. Revenue growth, operational results and advances to our business strategy depends on our ability to integrate any acquisitions into our existing business and effectively scale their operations. The integration of acquired assets may impact our revenue growth, increase the cost of operations or may require management resources that otherwise would be available for ongoing development of our existing business. • New product development. A significant aspect of our business is our investment in research and development activities, including activities related to the development of new products. In addition to the development of new product candidates, we believe these studies are critical to gaining clinician adoption of new products and driving favorable coverage decisions by payors for such products. Components of the Results of Operations Net Revenues We generate revenues from the sale of our products. Currently, our revenues are primarily derived from the sale of DecisionDx-Melanoma, DecisionDx-SCC, TissueCypher and DecisionDx-UM. We bill third-party payors and patients for the tests we perform. Under ASC 606, we recognize revenue at the amount we expect to be entitled, subject to a constraint for variable consideration, in the period in which our tests are delivered to the treating clinicians. We have determined that our contracts contain variable consideration under ASC 606 because the amounts paid by third-party payors may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration is recognized only to the extent it is probable that a significant reversal of revenue will not occur in future periods when the uncertainties are resolved. Variable consideration is evaluated each reporting 28 Table of Contents period and adjustments are recorded as increases or decreases in revenues. Variable consideration for Medicare claims that are not covered by Medicare, including those claims undergoing appeal, is deemed to be fully constrained due to factors outside our influence (e.g., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. For these fully constrained claims, we generally recognize revenue in the period the uncertainty is favorably resolved, if at all. Due to potential future changes in Medicare coverage policies and appeal cycles, insurance coverage policies, contractual rates and other trends in the reimbursement of our tests, our revenues may fluctuate significantly from period to period. Our ability to recognize revenue for a test is dependent on the development of reimbursement experience and obtaining coverage decisions. For tests with limited reimbursement experience or no coverage, we recognize revenues on the basis of actual cash collections. Our ability to increase our revenues will depend on our ability to further penetrate our target markets, and, in particular, generate sales through our direct sales force, develop and commercialize additional tests, including through acquisitions, obtain reimbursement from additional third-party payors and increase our reimbursement rate for tests performed. Cost of Sales (exclusive of amortization of acquired intangible assets) The components of our cost of sales are material and service costs associated with testing samples, personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), electronic medical record set up costs, order and delivery systems, shipping charges to transport samples, third-party test fees, and allocated overhead including rent, information technology costs, equipment and facilities depreciation and utilities. Costs associated with testing samples are recorded when the test is processed regardless of whether and when revenues are recognized with respect to that test. As a result, our cost of sales as a percentage of revenues may vary significantly from period to period because we do not recognize all revenues in the period in which the associated costs are incurred. We expect cost of sales in absolute dollars to increase as the number of tests we perform increases. Additionally, we expect cost of sales to increase with the expansion of laboratory capacity and staffing in advance of the anticipated growth of our more recently launched tests and tests acquired through acquisitions. For example, we commenced operations in a new expanded laboratory facility in Pittsburgh, Pennsylvania in the second quarter of 2023. Gross margin and gross margin percentage are key indicators we use to assess our business. See the table in “Results of Operations—Comparison of the Three Months ended June 30, 2023 and 2022” and “Results of Operations—Comparison of the Six Months ended June 30, 2023 and 2022“ for details. Research and Development Research and development expenses include costs incurred to develop our tests, collect clinical samples and conduct clinical studies to develop and support our products. These costs consist of personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), prototype materials, laboratory supplies, consulting costs, regulatory costs, electronic medical records set up costs, costs associated with setting up and conducting clinical studies and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses to increase in absolute dollars as we continue to invest in research and development activities related to developing enhanced and new products. We expect to use a portion of our cash and cash equivalents and marketable investment securities to further support and accelerate our research and development activities, including two important studies that are underway to support our DecisionDx-Melanoma test. The first is the CONNECTION study, which is collecting long-term outcomes for up to 10,000 patients who have been tested with DecisionDx-Melanoma. The second is the DECIDE study, which is designed to determine the association of GEP test results with sentinel lymph node biopsy (“SLNB”) surgical decisions in patients eligible for SLNB as well as to track outcomes for patients who did and did not undergo SLNB. In February 2023, we announced the publication of data from the DECIDE study presenting DecisionDx-Melanoma test results influenced 85% of clinicians’ decisions regarding the SLNB surgical procedure. Additionally, use of the tests’ results within current guideline recommendations led to a significant reduction in SLNB procedures performed, demonstrating the clinical value of the test to guide risk-aligned patient care. Also, in 2021, we initiated our IDENTITY Study, a 4,800 patient, prospective, multi-center clinical study to develop, validate and bring to market a pipeline test aimed at predicting response to systemic therapy in patients with moderate to severe psoriasis, atopic dermatitis and related inflammatory skin conditions. As of June 30, 2023, we have 57 committed sites and 759 patients enrolled in our IDENTITY study. We expect to obtain early developmental data from this study in the second half of 2023 and to launch this test in 2025. 29 Table of Contents Selling, General and Administrative Selling, general and administrative (“SG&A”) expenses include executive, selling and marketing, legal, finance and accounting, human resources and billing functions. These expenses consist of personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), direct marketing expenses, audit and legal expenses, consulting costs, payor outreach programs and allocated overhead, including rent, information technology, equipment depreciation, and utilities. Other administrative and professional services expenses within SG&A are expected to increase with the scale of our business, but selling and marketing-related expenses are expected to increase significantly, consistent with our growth strategy. Amortization of Acquired Intangible Assets Amortization of acquired intangible assets is primarily associated with developed technology obtained through acquisitions, such as our acquisitions of the Myriad MyPath Laboratory in May 2021, Cernostics in December 2021 and AltheaDx in April 2022. Change in Fair Value of Contingent Consideration Change in fair value of contingent consideration is associated with our acquisitions of Cernostics and AltheaDx and the related contingent consideration of up to $50.0 million and $75.0 million, respectively, payable based on the achievement of certain commercial milestones relating to the year ended December 31, 2022 in the case of Cernostics, and the years ending December 31, 2022, 2023 and 2024, in the case of AltheaDx (the “Earnout Payments”). No Earnout Payments were paid relating to the year ended December 31, 2022 in connection with our acquisitions of Cernostics and AltheaDx since the applicable commercial milestones were not achieved. As of June 30, 2023 and December 31, 2022, our contingent consideration liability for AltheaDx was zero. Interest Income Interest income consists primarily of earnings on cash and cash equivalents, primarily money market funds, and marketable investment securities, primarily short-term U.S. government obligations. Interest Expense Interest expense is primarily attributable to finance leases. Income Tax Expense (Benefit) In connection with our acquisition of AltheaDx in April 2022, and taking into consideration the additional deferred tax liabilities resulting from such acquisition, we determined that a portion of our valuation allowance should be reduced, which is reflected in our income tax benefit for the three and six months ended June 30, 2022. Our consolidated financial statements do not reflect any federal or state income tax benefits attributable to the pre-tax losses we have incurred, due to the uncertainty of realizing a benefit from those items. As of December 31, 2022, we had federal net operating loss (“NOL”) carryforwards of $207.2 million, of which $106.1 million will begin to expire in 2029 if not utilized to offset federal taxable income, and $101.1 million may be carried forward indefinitely. Also, as of December 31, 2022, we had state NOL carryforwards of $114.0 million, which begin to expire in 2028 if not utilized to offset state taxable income. 30 Table of Contents Results of Operations Comparison of the Three Months Ended June 30, 2023 and 2022 The following table summarizes our results of operations for the periods indicated (in thousands, except percentages): Three Months Ended June 30, Change 2023 2022 (unaudited) Net revenues $ 50,138 $ 34,838 $ 15,300 43.9 % Operating expenses and other operating income Cost of sales (exclusive of amortization of acquired intangible assets) 11,058 7,686 3,372 43.9 % Research and development 13,308 11,926 1,382 11.6 % Selling, general and administrative 44,681 37,498 7,183 19.2 % Amortization of acquired intangible assets 2,248 2,097 151 7.2 % Change in fair value of contingent consideration — (20,398) 20,398 100.0 % Total operating expenses, net 71,295 38,809 32,486 83.7 % Operating loss (21,157) (3,971) (17,186) (432.8) % Interest income 2,399 370 2,029 548.4 % Interest expense (3) (4) 1 25.0 % Loss before income taxes (18,761) (3,605) (15,156) (420.4) % Income tax expense (benefit) 16 (1,957) 1,973 100.8 % Net loss $ (18,777) $ (1,648) $ (17,129) NM NM = Not meaningful The following table indicates the amount of stock-based compensation expense (non-cash) reflected in the line items above (in thousands): Three Months Ended June 30, 2023 2022 Change (unaudited) Cost of sales (exclusive of amortization of acquired intangible assets) $ 1,202 $ 897 $ 305 Research and development 2,486 1,831 655 Selling, general and administrative 9,161 6,055 3,106 Total stock-based compensation expense $ 12,849 $ 8,783 $ 4,066 The following table provides a disaggregation of net revenues by type (in thousands): Three Months Ended June 30, 2023 2022 Change (unaudited) Dermatologic (1) $ 43,030 $ 31,897 $ 11,133 Non-Dermatologic (2) 7,108 2,941 4,167 Total net revenues $ 50,138 $ 34,838 $ 15,300 (1) Consists of DecisionDx-Melanoma, DecisionDx-SCC and our Diagnostic GEP offering. (2) Consists of TissueCypher, DecisionDx-UM and IDgenetix. 31 Table of Contents The following table presents the calculation of gross margin (in thousands, except percentages): Three Months Ended June 30, 2023 2022 Change (unaudited) Net revenues $ 50,138 $ 34,838 $ 15,300 Less: Cost of sales (exclusive of amortization of acquired intangible assets) 11,058 7,686 3,372 Less: Amortization of acquired intangible assets 2,248 2,097 151 Gross margin $ 36,832 $ 25,055 $ 11,777 Gross margin percentage 73.5 % 71.9 % 1.6 % Net Revenues Net revenues for the three months ended June 30, 2023 increased by $15.3 million, or 43.9%, to $50.1 million compared to the three months ended June 30, 2022, due to a $11.1 million increase in revenue from our dermatologic tests and a $4.2 million increase in revenue from our non-dermatologic tests. The increase from our dermatologic tests was primarily due to increases in test report volume of 20.7% for DecisionDx-Melanoma and 99.5% for DecisionDx-SCC, and a slightly higher average selling price for DecisionDx-Melanoma. The increase in revenue from our non-dermatologic tests of $4.2 million was primarily attributable to the effect of the increase in the Medicare reimbursement rate for our TissueCypher test and higher test report volume during the second quarter of 2023 compared to the second quarter of 2022. The increases in total net revenues were partially offset by the effect of variations in revenue adjustments related to tests delivered in previous periods, associated with changes in estimated variable consideration, which were $0.1 million of net negative revenue adjustments for the three months ended June 30, 2023, compared to $0.6 million of net positive revenue adjustments for the three months ended June 30, 2022. These amounts include (i) adjustments for actual collections versus estimated amounts and (ii) cash collections and the related recognition of revenue in current period for tests delivered in prior periods due to the release of the constraint on variable consideration. Cost of Sales (exclusive of amortization of acquired intangible assets) Cost of sales (exclusive of amortization of acquired intangible assets) for the three months ended June 30, 2023 increased by $3.4 million, or 43.9%, compared to the three months ended June 30, 2022, primarily due to increased expenditures on supplies, higher personnel costs, third-party services and rent. Supply and service expenses increased largely due to our higher test volumes. The increase in personnel costs consists of higher salaries and wages, stock-based compensation expense and benefits related to headcount additions as well as existing employees. Due to the nature of our business, a significant portion of our cost of sales expenses represents fixed costs associated with our testing operations. Accordingly, our cost of sales expense will not necessarily increase or decrease commensurately with the change in net revenues from period to period. We expect our cost of sales expenses (exclusive of amortization of acquired intangible assets) to continue to increase in future periods as we hire additional laboratory personnel and related resources to support our expected growth in volume for our dermatologic, gastrointestinal, mental health and pipeline tests. Gross Margin Our gross margin percentage was 73.5% for the three months ended June 30, 2023, compared to 71.9% for the same period in 2022. The increase was primarily due to higher revenues which were attributable to increases in both test report volumes and average selling prices, partially offset by higher supplies expenditures and higher personnel costs, both of which have increased due to our expanded laboratory capacity and higher test report volumes. Research and Development Research and development expenses increased by $1.4 million, or 11.6%, for the three months ended June 30, 2023, compared to the three months ended June 30, 2022. A majority of the increase was attributable to higher personnel costs, primarily due to expansions in headcount in support of our growth, higher salaries and wages and 32 Table of Contents higher stock-based compensation expense. Additionally, 20.0% of the increase is due to higher costs for clinical studies, most of which relates to our IDENTITY study and our inflammatory skin disease pipeline test. Increases in personnel and clinical studies expenses were partially offset by slightly lower advisory costs. We expect to continue to increase our research and development expenses as we fund ongoing evidence development related to our existing products as well as additional pipeline programs. Selling, General and Administrative The following table provides a breakdown of SG&A expenses (in thousands): Three Months Ended June 30, 2023 2022 Change (unaudited) Sales and marketing $ 28,252 $ 21,581 $ 6,671 General and administrative 16,429 15,917 512 Total selling, general and administrative expense $ 44,681 $ 37,498 $ 7,183 Sales and marketing expenses increased by $6.7 million, or 30.9%, for the three months ended June 30, 2023, compared to the three months ended June 30, 2022. Of the increase, 68.4% is attributable to higher personnel costs, including salaries, stock-based compensation and bonuses. Personnel costs have increased through the expansions of our dermatology-facing and non-dermatology-facing commercial teams and outside sales forces, as described above. In addition, higher personnel costs also reflect salary increases for members of our existing sales force. The remainder of the increase in sales and marketing expenses was primarily associated with travel, conferences and other marketing costs, attributable to our expanded commercial operations and headcount. Stock-based compensation expense included in sales and marketing was $4.7 million for the three months ended June 30, 2023, compared to $2.9 million for the three months ended June 30, 2022. General and administrative expenses increased by $0.5 million, or 3.2%, for the three months ended June 30, 2023, compared to the three months ended June 30, 2022. The increase is primarily attributable to $1.0 million in higher personnel costs and $1.0 million in higher information technology-related costs. Increases in personnel costs reflect higher stock-based compensation and salaries, partially offset by lower bonus expense and employee benefits. Higher personnel costs reflect expanded headcount in our administrative support functions, as well as higher rates of salaries and wages. Increases in personnel costs and information technology-related costs were partially offset by a reduction of professional fees of $1.5 million, primarily due to transaction costs incurred in connection with our acquisition of AltheaDx during the three months ended June 30, 2022. Stock-based compensation expense included in general and administrative expense was $4.5 million for the three months ended June 30, 2023, compared to $3.2 million for the three months ended June 30, 2022. Change in Fair Value of Contingent Consideration The change in fair value of contingent consideration for the three months ended June 30, 2022 of $20.4 million, a net gain, was primarily related to the remeasurement of the Earnout Payments associated with our acquisition of Cernostics with no similar activity occurring in the second quarter of 2023 . Interest Income Interest income increased by $2.0 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022, primarily as a result of higher interest rates and our purchases of marketable investment securities beginning in the third quarter of 2022. Income Tax Expense (Benefit) We recorded a minimal amount in income tax expense for the three months ended June 30, 2023. Our income tax benefit was $2.0 million for the three months ended June 30, 2022 and was primarily attributable to a reduction of $1.8 million in our valuation allowance on net deferred tax assets resulting from our acquisition of AltheaDx in April 2022. Specifically, we took into consideration the additional deferred tax liabilities resulting from the acquisition and determined that a portion of our existing valuation allowance should be reduced. Stock-Based Compensation Expense Stock-based compensation expense, which is allocated among cost of sales, research and development expense and SG&A expense, totaled $12.8 million for the three months ended June 30, 2023, compared to $8.8 million for 33 Table of Contents the three months ended June 30, 2022. The increase is primarily due to our annual grant of equity awards in December 2022. We expect material increases in stock-based compensation expense in future periods, attributable to both existing awards outstanding and anticipated additional grants to our current and future employees. As of June 30, 2023, we had 582 employees compared to 482 as of June 30, 2022. As of June 30, 2023, the total unrecognized stock-based compensation cost related to outstanding awards was $108.9 million, which is expected to be recognized over a weighted-average period of 2.6 years. Comparison of the Six Months Ended June 30, 2023 and 2022 The following table summarizes our results of operations for the periods indicated (in thousands, except percentages): Six Months Ended June 30, Change 2023 2022 (unaudited) Net revenues $ 92,175 $ 61,690 $ 30,485 49.4 % Operating expenses and other operating income Cost of sales (exclusive of amortization of acquired intangible assets) 21,240 13,630 7,610 55.8 % Research and development 27,701 22,687 5,014 22.1 % Selling, general and administrative 91,443 67,951 23,492 34.6 % Amortization of acquired intangible assets 4,470 3,745 725 19.4 % Change in fair value of contingent consideration — (17,836) 17,836 100.0 % Total operating expenses, net 144,854 90,177 54,677 60.6 % Operating loss (52,679) (28,487) (24,192) (84.9) % Interest income 4,735 400 4,335 NM Interest expense (7) (7) — — % Loss before income taxes (47,951) (28,094) (19,857) (70.7) % Income tax expense (benefit) 30 (1,823) 1,853 101.6 % Net loss $ (47,981) $ (26,271) $ (21,710) (82.6) % NM = Not meaningful The following table indicates the amount of stock-based compensation expense (non-cash) reflected in the line items above (in thousands): Six Months Ended June 30, 2023 2022 Change (unaudited) Cost of sales (exclusive of amortization of acquired intangible assets) $ 2,474 $ 1,750 $ 724 Research and development 5,073 3,659 1,414 Selling, general and administrative 18,827 11,793 7,034 Total stock-based compensation expense $ 26,374 $ 17,202 $ 9,172 34 Table of Contents The following table provides a disaggregation of net revenues by type (in thousands): Six Months Ended June 30, 2023 2022 Change (unaudited) Dermatologic (1) $ 78,941 $ 56,236 $ 22,705 Non-Dermatologic (2) 13,234 5,454 7,780 Total net revenues $ 92,175 $ 61,690 $ 30,485 (1) Consists of DecisionDx-Melanoma, DecisionDx-SCC and our Diagnostic GEP offering. (2) Consists of TissueCypher, DecisionDx-UM and IDgenetix. The following table presents the calculation of gross margin (in thousands, except percentages): Six Months Ended June 30, 2023 2022 Change (unaudited) Net revenues $ 92,175 $ 61,690 $ 30,485 Less: Cost of sales (exclusive of amortization of acquired intangible assets) 21,240 13,630 7,610 Less: Amortization of acquired intangible assets 4,470 3,745 725 Gross margin $ 66,465 $ 44,315 $ 22,150 Gross margin percentage 72.1 % 71.8 % 0.3 % Net Revenues Net revenues for the six months ended June 30, 2023 increased by $30.5 million, or 49.4%, to $92.2 million compared to the six months ended June 30, 2022, due to a $22.7 million increase in revenue from our dermatologic tests and a $7.8 million increase in revenue from our non-dermatologic tests. The increase from our dermatologic tests was primarily due to increases in test report volume of 23.1% for DecisionDx-Melanoma and 104.8% for DecisionDx-SCC. We began receiving Medicare coverage for DecisionDx-SCC tests in the second quarter of 2022, which also contributed to the increase in revenue. The increase in revenue from our non-dermatologic tests of $7.8 million was primarily attributable to higher test report volume and the effect of the increase in the Medicare reimbursement rate for our TissueCypher test during the six months ended June 30, 2023 compared to the same period of 2022. Our IDgenetix test, which we acquired in connection with our acquisition of AltheaDx in April 2022, also contributed to the increase in non-dermatologic revenues during the period. The increases in total net revenues were partially offset by the effect of variations in revenue adjustments related to tests delivered in previous periods, associated with changes in estimated variable consideration, which were $1.7 million of net negative revenue adjustments for the six months ended June 30, 2023, compared to $0.3 million of net negative revenue adjustments for the same period in 2022. These amounts include (i) adjustments for actual collections versus estimated amounts and (ii) cash collections and the related recognition of revenue in current period for tests delivered in prior periods due to the release of the constraint on variable consideration. Cost of Sales (exclusive of amortization of acquired intangible assets) Cost of sales (exclusive of amortization of acquired intangible assets) for the six months ended June 30, 2023 increased by $7.6 million, or 55.8%, compared to the six months ended June 30, 2022, primarily due to increased expenditures on supplies, higher personnel costs, third-party services and rent. Supply and service expenses have increased due to higher laboratory activity, which is attributable to higher test report volume. The increase in personnel costs, including increases in salaries and wages, stock-based compensation expense and benefits, was primarily due to increased headcount driven by our expanded laboratory capacity. The increased personnel costs also reflect higher salaries and wages for existing employees. Due to the nature of our business, a significant 35 Table of Contents portion of our cost of sales expenses represents fixed costs associated with our testing operations. Accordingly, our cost of sales expense will not necessarily increase or decrease commensurately with the change in net revenues from period to period. We expect our cost of sales expenses (exclusive of amortization of acquired intangible assets) to continue to increase in future periods as we hire additional laboratory personnel and related resources to support our expected growth in volume for our dermatologic, gastrointestinal, mental health and pipeline tests. Gross Margin Our gross margin percentage was 72.1% for the six months ended June 30, 2023, compared to 71.8% for the six months ended June 30, 2022. The increase was primarily due to higher revenues, partially offset by higher supplies expenditures, personnel costs, attributable to increases in laboratory headcount as well as higher rates of pay, and variations in revenue adjustments related to tests delivered in previous periods. Research and Development Research and development expenses increased by $5.0 million, or 22.1%, for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. Higher personnel costs comprise 79.8% of the increase and were primarily due to expansions in headcount in support of our growth, higher salaries and wages, higher stock-based compensation expense and employee benefits. Additionally, 24.2% is attributable to higher costs for clinical studies, most of which was attributable to our IDENTITY study and our inflammatory skin disease pipeline test. Increases in personnel and clinical studies expenses were partially offset by slightly lower advisory costs. We expect to continue to increase our research and development expenses as we fund ongoing evidence development related to our existing products as well as additional pipeline programs. Selling, General and Administrative The following table provides a breakdown of SG&A expenses (in thousands): Six Months Ended June 30, 2023 2022 Change (unaudited) Sales and marketing $ 58,197 $ 39,802 $ 18,395 General and administrative 33,246 28,149 5,097 Total selling, general and administrative expense $ 91,443 $ 67,951 $ 23,492 Sales and marketing expenses increased by $18.4 million, or 46.2%, for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. Of the increase, 62.9% is attributable to higher personnel costs, including salaries, stock-based compensation and bonuses. Personnel costs have increased through the expansions of our dermatology-facing and non-dermatology-facing commercial teams and outside sales forces. In addition, higher personnel costs also reflect salary increases for members of our existing sales force. The remainder of the increase in sales and marketing expenses was primarily associated with travel, training events, conference fees and other marketing costs, attributable to our expanded commercial operations and headcount. Stock-based compensation expense included in sales and marketing expense was $9.6 million for the six months ended June 30, 2023, compared to $5.7 million for the six months ended June 30, 2022. General and administrative expenses increased by $5.1 million, or 18.1%, for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. The increase is primarily attributable to $4.4 million in higher personnel costs and $1.0 million in higher information technology-related costs. Increases in personnel costs reflect higher stock-based compensation and salaries. The higher personnel costs reflect expanded headcount in our administrative support functions as well as higher rates of salaries and wages. Increases in personnel costs and information technology-related costs were partially offset by a decrease in professional fees, primarily due to transaction costs incurred in connection with our acquisition of AltheaDx during the six months ended June 30, 2022. Stock-based compensation expense included in general and administrative expense was $9.2 million for the six months ended June 30, 2023, compared to $6.1 million for the six months ended June 30, 2022. The remainder of the increase in general and administrative expenses was primarily associated with general increases across various categories. 36 Table of Contents Amortization of Acquired Intangible Assets Amortization of acquired intangible assets increased by $0.7 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. The increase is primarily associated with amortization of developed technology attributable to the acquisition of AltheaDx in April 2022. Change in Fair Value of Contingent Consideration The change in fair value of contingent consideration for the six months ended June 30, 2022 of $17.8 million, a net gain, was primarily related to the remeasurement of the Earnout Payments associated with our acquisition of Cernostics. There was no such activity during the six months ended June 30, 2023. Interest Income Interest income increased by $4.3 million for the six months ended June 30, 2023 , compared to the six months ended June 30, 2022 , primarily as a result of higher interest rates and our purchases of marketable investment securities beginning in the third quarter of 2022. Income Tax Expense (Benefit) We recorded a minimal amount in income tax expense for the six months ended June 30, 2023 . Our income tax benefit was $1.8 million for the six months ended June 30, 2022, and was primarily attributable to a reduction of $1.8 million in our valuation allowance on net deferred tax assets resulting from our acquisition of AltheaDx in April 2022. Specifically, we took into consideration the additional deferred tax liabilities resulting from the acquisition and determined that a portion of our existing valuation allowance should be reduced. Stock-Based Compensation Expense Stock-based compensation expense, which is allocated among cost of sales, research and development expense and SG&A expense, totaled $26.4 million for the six months ended June 30, 2023, compared to $17.2 million for the six months ended June 30, 2022. The increase is primarily due to our annual grant of equity awards in December 2022. We expect material increases in stock-based compensation expense in future periods, attributable to both existing awards outstanding and anticipated additional grants to our current and future employees. As of June 30, 2023, we had 582 employees compared to 482 as of June 30, 2022. As of June 30, 2023, the total unrecognized stock-based compensation cost related to outstanding awards was $108.9 million, which is expected to be recognized over a weighted-average period of 2.6 years. Liquidity and Capital Resources Sources of Liquidity Our principal sources of liquidity are our cash and cash equivalents, marketable investment securities and cash generated from the sale of our products. All of our marketable investment securities are considered investment grade, are readily available for use in current operations and have contractual maturities of one year or less. As of June 30, 2023 and December 31, 2022, we had marketable investment securities of $129.6 million and $135.7 million, respectively. As of June 30, 2023 and December 31, 2022, we had cash and cash equivalents of $95.9 million and $122.9 million, respectively. Since becoming a public company, our liquidity has been primarily derived from the revenue generated from the sale of our products, proceeds from our initial public offering of common stock on July 29, 2019 (the “IPO”), follow-on public offerings of common stock in June 2020 and December 2020 and bank debt, which has since been repaid in full. We believe that our existing cash and cash equivalents, marketable investment securities and anticipated cash generated from sales of our products will be sufficient to fund our operations through 2025. However, we have based these estimates on assumptions that may prove to be wrong, and could result in us depleting our capital resources sooner than expected. As mentioned above, we expect to use a portion of our cash and cash equivalents and marketable investment securities to further support and accelerate our research and development activities, including the clinical studies noted above in “Components of the Results of Operations—Research and Development.” Material Cash Requirements Our primary uses of capital are, and we expect will continue to be, compensation and related expenses, clinical research and development services, laboratory operations, equipment and related supplies, legal and other regulatory expenses, general administrative costs and, from time to time, expansion of our laboratory and office facilities in support of our growth. We anticipate that a substantial portion of our cash requirements in the 37 Table of Contents foreseeable future will relate to the further commercialization of our currently marketed products, the development of our future product candidates in our pipeline and the potential commercialization of these pipeline products, should their development be successful. In April 2022, we acquired AltheaDx, for $30.5 million in cash and $17.1 million in shares of our common stock. We agreed to pay contingent consideration of up $75.0 million, 50% in cash and 50% in common stock, based on the achievement of certain commercial milestones relating to the years ending December 31, 2022, 2023 and 2024. The portion associated with the commercial milestones for the year ended December 31, 2022 was not paid since the applicable commercial milestones were not met. This portion represented $35.0 million of the $75.0 million total potential payment obligation, exclusive of a potential catch-up payment in 2023 of $17.5 million which will become payable if all 2023 commercial milestones are fully met. Therefore, as of June 30, 2023, we have a potential payment obligation of up to $57.5 million with respect to the remaining commercial milestones for 2023 and 2024. In each case, the number of shares of our common stock that may be issued in connection with the commercial milestone payments is subject to limitations. Our actual liability with respect to these commercial milestone payments from our acquisition will depend, in part, on our ability to successfully integrate IDgenetix (acquired from AltheaDx) into our suite of commercial product offerings and the timing thereof. See Note 6 of the unaudited condensed consolidated financial statements for additional information on the acquisition of AltheaDx. On July 10, 2023, following approval by our board of directors, we entered into a definitive agreement to purchase a plot of land located in Friendswood, Texas for a purchase price of $7.6 million, subject to certain adjustments, for the purpose of developing a commercial office building which may be used as our future corporate headquarters. We have the option to terminate the contract within 90 days, for any reason, and will use this time to complete initial suitability diligence. Closing, if it should occur, is expected in late 2023. Since our inception, we have generally incurred significant losses and negative cash flows. For the year ended December 31, 2022 we had a net loss of $67.1 million and an accumulated deficit of $160.9 million as of December 31, 2022. For the six months ended June 30, 2023, we had a net loss of $48.0 million and an accumulated deficit of $208.9 million as of June 30, 2023. Our ability to generate revenue sufficient to achieve profitability will depend heavily on the successful commercialization of our currently marketed products and the products we plan to launch in the future as well as our spending on research and development activities. We expect to incur additional expenses and losses in the future as we invest in the commercialization of our existing products and the development and commercialization of our current pipeline products and future product candidates. Further, we expect that any acquisitions of businesses, products, assets or technologies will also increase our expenses. We believe that our existing cash and cash equivalents, marketable investment securities and anticipated cash generated from the sale of our commercial products will be sufficient to fund our operations for at least the next 12 months and for the foreseeable future. We believe we will meet longer-term expected cash requirements and obligations through a combination of existing cash and cash equivalents, marketable investment securities and anticipated cash generated from sales of our products and issuances of equity securities or debt offerings. However, we have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. There are numerous risks and uncertainties associated with developing genomic tests, including, among others, the uncertainty of: • successful commencement and completion of clinical study protocols; • successful identification and acquisition of tissue samples; • the development and validation of genomic classifiers; and • acceptance of new genomic tests by clinicians, patients and third-party payors. Because of the numerous risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate our exact working capital requirements. Our future funding requirements will depend on and could increase significantly as a result of, many factors, including those listed above as well as those listed in Part II, Item 1A., “Risk Factors” in this Quarterly Report on Form 10-Q. We do not currently have any committed external source of funds. In the event additional funding is required, we expect that we would use a combination of equity and debt financings, which may not be available to us when needed, on terms that we deem to be favorable or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. Any disruptions to, or volatility in, the credit and financial 38 Table of Contents markets or any deterioration in overall economic conditions may make any necessary debt or equity financing more difficult to obtain, more costly and/or more dilutive. If we are unable to raise additional funds through debt or equity financing or other arrangements when needed, we may be required to delay, limit, reduce or terminate our product discovery and development activities or future commercialization efforts. Leases We have entered into various operating and finance leases, which are primarily associated with our laboratory facilities and office space. Total undiscounted future minimum payment obligations under our operating leases and finance leases as of June 30, 2023 totaled approximately $23.7 million, of which $1.1 million is payable through the remainder of 2023 and $22.6 million is payable through the end of 2033. The leases expire on various dates through 2033 and provide certain options to renew for additional periods. On April 18, 2023, we amended an existing lease agreement to lease additional laboratory space in Phoenix, Arizona. Upon taking possession of the additional laboratory space, we expect our undiscounted future minimum payment obligations to increase by approximately $1.7 million. We expect our lease obligations may increase in the future as we expand our facilities, operations and headcount in support of the anticipated growth in our portfolio of commercial products and pipeline tests. Cash Flows The following table summarizes our sources and uses of cash and cash equivalents for each of the periods presented (in thousands): Six Months Ended June 30, 2023 2022 (unaudited) Net cash used in operating activities $ (29,225) $ (30,431) Net cash provided by (used in) investing activities 1,197 (27,913) Net cash provided by financing activities 954 1,877 Net change in cash and cash equivalents (27,074) (56,467) Cash and cash equivalents, beginning of period 122,948 329,633 Cash and cash equivalents, end of period $ 95,874 $ 273,166 Operating Activities Net cash used in operating activities was $29.2 million for the six months ended June 30, 2023, and was primarily attributable to the net loss of $48.0 million, increases in accounts receivable of $8.0 million, decreases in accrued compensation of $7.1 million, increases in accretion of discounts on marketable investment securities of $2.3 million and increases in inventory of $2.1 million, partially offset by non-cash stock-based compensation expense of $26.4 million, depreciation and amortization of $5.9 million, a change in accounts payable of $3.1 million and a change in other accrued and current liabilities of $2.0 million. Net cash used in operating activities was $30.4 million for the six months ended June 30, 2022, and was primarily attributable to the net loss of $26.3 million, the change in fair value of contingent consideration of $17.8 million, increases in accounts receivable of $5.6 million and deferred income taxes of $1.8 million, partially offset by non-cash stock-based compensation expense of $17.2 million and depreciation and amortization of $4.8 million. The $1.2 million decrease in net cash used in operating activities for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 is primarily due to increases in collections from customers attributable to higher net revenues partially offset by increases in operating expenditures. In part, the cash used during the first half of 2023 reflects the payment of annual cash bonuses to our employees as well as certain health care benefit payments totaling $17.7 million, that are not expected to recur during the remainder of 2023. In comparison, we paid $11.6 million during the same period in 2022 towards annual cash bonuses and certain health care benefits. Investing Activities Net cash provided by investing activities was $1.2 million for the six months ended June 30, 2023 and consisted primarily of the maturity of marketable investment securities of $95.0 million, partially offset by purchases of marketable investment securities of $86.4 million and purchases of property and equipment of $7.4 million. Net cash 39 Table of Contents used in investing activities was $27.9 million for the six months ended June 30, 2022 and consisted primarily of the cash portion of the purchase price of $26.7 million (net of cash and cash equivalents acquired) paid for our acquisition of AltheaDx and the purchase of property and equipment of $1.8 million. The $5.6 million increase in cash used for the purchase of property and equipment for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was primarily due to the build out and completion of our new laboratory and office facilities located in Pittsburgh, Pennsylvania. Fixed asset purchases for this build out included those made for leasehold improvements, furniture and fixtures, new laboratory equipment and information technology infrastructure. Financing Activities Net cash provided by financing activities was $1.0 million for the six months ended June 30, 2023, and consisted primarily of $1.7 million of proceeds from contributions to our 2019 Employee Stock Purchase Plan (the “ESPP”), $0.2 million of proceeds from exercise of common stock options, partially offset by the $0.8 million payment of employee taxes attributable to the vesting of Restricted Stock Units (“RSUs”). Net cash provided by financing activities was $1.9 million for the six months ended June 30, 2022, and primarily consisted of $1.5 million in proceeds from contributions to the ESPP and $0.5 million in proceeds from the exercise of stock options. Inflation In 2021, the rate of inflation in the United States began to increase but has continued to subside since the second half of 2022. We do not believe that inflation has had a material impact on our financial results during the three and six months ended June 30, 2023. We are unable to predict if the rate of inflation will increase in future periods. Critical Accounting Estimates During the six months ended June 30, 2023, except as noted below, there were no significant changes to the information discussed under “Critical Accounting Estimates” included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2022. The following is an updated discussion of our critical accounting estimates related to goodwill impairment testing and requisite service period for stock-based compensation. This information should be read in conjunction with our other information on critical accounting estimates included in our Annual Report on Form 10-K for the year ended December 31, 2022. Goodwill—Impairment Testing On June 2, 2023, a MAC finalized an LCD pursuant to which the DecisionDx-SCC test would no longer be covered by Medicare effective July 17, 2023. On June 5, 2023, our stock price decreased significantly and did not recover before June 30, 2023. In response to this trigger, we tested goodwill for impairment at June 30, 2023. We elected to bypass the optional qualitative assessment and proceeded directly to the quantitative assessment. In conducting our interim test, we concluded that our business consists of a single reporting unit. To measure the fair value of our reporting unit, we used a market approach whereby we calculated our total market capitalization on the impairment test date, based on the closing price of our common stock as reported on the Nasdaq Global Market, and applied a reasonable control premium. The control premium was based on an analysis of control premiums paid in recent acquisitions of companies in the same or similar industry as us. Our impairment test indicated that the fair value of our reporting unit exceeded its carrying value by 13% and therefore no impairment was indicated. In July 2023, the MAC suspended the LCD and then posted a new draft LCD for comment that is substantially the same as the LCD that was to become effective. Factors that could result in a future impairment of goodwill include declines in the price of our common stock, increased competition, changes in macroeconomic developments, unfavorable government or regulatory developments and changes in coverage or reimbursement conditions. Stock-Based Compensation—Requisite Service Period For awards with graded vesting and only service conditions, we recognize compensation costs on a straight-line basis over the requisite service period of the awards. For options and RSUs, the requisite service period is generally the awards’ vesting period (typically four years). Performance-based restricted stock units (“PSUs”) vest upon the achievement of certain performance conditions and the provision of service with us through a specified period. Accruals of compensation cost for PSUs are based on the probable outcome of the performance conditions and are 40 Table of Contents reassessed each reporting period. We recognize compensation cost for PSUs separately for each vesting tranche on a ratable basis over the requisite service period. The requisite service period for PSUs is based on an analysis of vesting requirements and performance conditions for the particular award. Certain employees are entitled to acceleration of vesting of a portion of their awards upon retirement, subject to age, service and notice requirements. In these cases, the requisite service period takes into consideration the employee’s retirement eligibility, and is reassessed at each reporting date. For the ESPP, the requisite service period is generally the period of time from the offering date to the purchase date. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As a smaller reporting company, we are not required to provide the information required by this Item.